Upstairs Market Research Articles

The impact of upstairs trading on market quality: evidence from a highly segmented market*

Using data on over 18 million trades from the New Zealand Stock Exchange (NZX), this paper examines how market segmentation affects overall market quality in a market that until recently had no restrictions on trading outside the central limit order book (LOB). We find that upstairs trading results in lower transaction costs, larger trade size and lower volatility. A newly implemented minimum size requirement for trades in the upstairs market has the desired outcome and further lowers transaction costs and volatility due to reduced market segmentation. The results suggest that a functional upstairs market can have a positive impact on market quality if well-designed.

From upstairs to downstairs trading: Evidence from a highly segmented market

Using data on more than 18 million trades, this paper examines the information content of trades in a highly segmented market that until recently had no restrictions on trading outside the central limit order book (LOB). Consistent with theoretical predictions and earlier findings, we largely confirm that the permanent price effect is significantly lower in the upstairs market than downstairs. Furthermore, we find that a newly implemented minimum size requirement for trades in the upstairs market works as intended by the market provider. However, trades that are exempt from this requirement and small, informed institutional trades carry more information content in the upstairs market.

The price effect of block trades: evidence from the Tunisian Stock Exchange

This paper analyses the impact of block trades (upstairs market) on the Tunisian Stock Exchange from January 2, 2008 to December 31, 2017. We find that the buyer-initiated trades in upstairs market have a positive temporary impact on the main market which confirms the liquidity hypotheses. The Tunisian market is found to react positively after the block initiated by a seller, which is not unexpected. This reaction can be explained by the visibility hypothesis initially developed by Miller (1977) who argues that a volume shock increases the probability that an investor is interested in buying this stock especially when short selling is limited or prohibited. We also think that some Tunisian investors (individual small shareholders) react regardless of the direction of the block transaction, showing a naive behaviour. Our results reject the information hypothesis suggesting that the upstairs brokers have the informational advantage about unexpressed demand and thus the market can absorb large block trades (Grossman, 1992). Then, we highlight the information leakage dealing with block trades according to the position of block brokers (application negotiation or construction pools of counterparts).

The price effect of block trades: evidence from the Tunisian Stock Exchange

This paper analyses the impact of block trades (upstairs market) on the Tunisian Stock Exchange from January 2, 2008 to December 31, 2017. We find that the buyer-initiated trades in upstairs market have a positive temporary impact on the main market which confirms the liquidity hypotheses. The Tunisian market is found to react positively after the block initiated by a seller, which is not unexpected. This reaction can be explained by the visibility hypothesis initially developed by Miller (1977) who argues that a volume shock increases the probability that an investor is interested in buying this stock especially when short selling is limited or prohibited. We also think that some Tunisian investors (individual small shareholders) react regardless of the direction of the block transaction, showing a naive behaviour. Our results reject the information hypothesis suggesting that the upstairs brokers have the informational advantage about unexpressed demand and thus the market can absorb large block trades (Grossman, 1992). Then, we highlight the information leakage dealing with block trades according to the position of block brokers (application negotiation or construction pools of counterparts).

Block trades in options markets

AbstractBlock trading, which was sparse before the reduction of the minimum permissible block size threshold in October 2012, currently accounts for about 30% of the trading volume in WTI crude oil options. Block orders share similar characteristics to those routed at the pit, but they have lower information content and face higher execution costs, due to high search costs. However, our results show that such block orders would have been costlier to execute at the pit, which suggests that some pit order flow may have migrated to the upstairs market, contributing to the eventual demise of energy options pits.

The impact of large orders in electronic markets

This paper uses order-level data of all traders of the Italian stock exchange Borsa Italiana (BI) to resolve three issues that remained unsettled in the extant microstructure literature: the interaction between the exchange and a parallel market for large blocks; the asymmetry between the price impacts of buy and sell orders; and the behaviour of liquidity in the limit order book around large orders. Price impacts and liquidity e↵ects of block trades at BI are surprisingly di↵erent from existing empirical literature. Our findings reveal that price e↵ects are much lower in the electronic downstairs market than in the upstairs market. Such result is the opposite of what can be found in previous studies. Moreover, trading costs in the central limit order book at BI are lower than in any other exchange analysed in the past. We explain that in terms of exchange trading architecture. In fact, rules on block trading at BI allowed a parallel dark pool to coexist with the consolidated limit order book well before market liberalization was introduced by the MIFID directive. This left the downstairs market with a selection of liquidity-driven orders and unprecedented low price impacts.

Does an Electronic Stock Exchange Need an Upstairs Market?

We examine the Paris Bourse, whose electronic limit order market closely resembles the downstairs markets envisioned by theorists, to test several theoretical predictions regarding upstairs trading. We present direct evidence in support of the Grossman (1992) prediction that upstairs brokers lower execution costs by tapping into unexpressed liquidity, as actual execution costs upstairs are on average only 20% (35%) as large as they would be if block trades were executed against displayed (displayed and hidden) liquidity in the downstairs limit order book. Consistent with prior analyses, the Paris data also support the Seppi (1990) hypothesis that upstairs brokers certify trades as uninformed. We also find that participants in stocks with less restrictive crossing rules agree to outside-the-quote executions for more difficult trades and at times when downstairs liquidity is lacking. These likely represent trades that could not have been otherwise completed, suggesting that market quality can be enhanced by allowing participants more flexibility to execute blocks at prices outside the quotes.

Does the London Stock Exchange require an upstairs market? Evidence from block trades

Purpose – The purpose of this paper is to test if the empirical relationship between the size of trades and market liquidity can be pooled across different block sizes on the London Stock Exchange (LSE). Design/methodology/approach – The authors use pooling and non-pooling econometric tests in a panel framework. Findings – When the authors differentiate between various block sizes, the authors find that for trades in excess of 50,000 shares, there is a positive association between the size of the trade and the bid-ask spread, due to a lack of liquidity in the financial market. The results provide strong evidence that an upstairs market may be required in order to provide liquidity for large block trades on the LSE. Originality/value – This is the first study to directly test if the LSE requires an upstairs market to provide liquidity for large trade transactions.

Why Automated Trading Venues Need Upstairs Markets

1 Abstract The paper presents new evidence on the contribution to price discovery of the upstairs market. The 'component share' and 'information share' measures are used, supplemented by the probability of informed trading (PIN) analysis. Most discovery arises downstairs, consistent with previous findings. But the upstairs market makes a non-negligible contribution, which approaches that of the downstairs market at the start and close of the day. The PIN estimates indicate that a higher proportion of upstairs than downstairs trades are informed. The upstairs has a larger role in price discovery than previous evidence suggests.

The informational effect and market quality impact of upstairs trading and fleeting orders on the Australian Securities Exchange

Abstract This paper investigates the informational effect of trading and market segmentation on the Australian Securities Exchange (ASX) paying particular attention to the recent phenomenon: fleeting orders. 1 Confirming theoretical predictions, this study finds that permanent price effect (PPE) is significantly greater in the central limit order book (LOB) than in the upstairs market and that less informed institutional trades are routed to the upstairs market. It also finds that a well functioning upstairs market often results in lower transaction cost, higher volatility and larger trade size on the ASX. In the context of fleeting orders specifically, it finds the informational effect and market quality impact of upstairs market to be weaker after removing fleeting orders, which subsequently leads to the conclusion that recently introduced execution algorithms, which leave a trace of fleeting orders, often result in lower PPE and are mostly used my uninformed liquidity traders.

The Impact of Large Orders in Electronic Markets

This paper uses order-level data of all investors of the Italian stock exchange Borsa Italiana (BI) to resolve three issues that remained unsettled in the extant microstructure literature: the interaction between the exchange and a parallel market for large blocks; the asymmetry between the price impacts of buy and sell orders; and the behaviour of liquidity in the limit order book around large orders. Price impacts and liquidity effects of block trades at BI are surprisingly different from existing empirical literature. Our findings reveal that price effects are much lower in the electronic downstairs market than in the upstairs market. Such result is the opposite of what can be found in previous studies. Moreover, trading costs in the central limit order book at BI are lower than in any other exchange analysed in the past. We explain that in terms of exchange trading architecture. In fact, rules on block trading at BI allowed a parallel over-the-counter market to coexist with the consolidated limit order book well before market liberalization was introduced by the MIFID directive. This left the downstairs market with a selection of liquidity-driven orders and unprecedented low price impacts.

The implications of a price anchoring effect at the upstairs market of the London Stock Exchange

This paper studies the upstairs market of the Stock Exchange Trading System (SETS) of the London Stock Exchange (LSE). We hypothesise that the implicit interaction between the upstairs and the downstairs markets at the LSE alters the pricing mechanism at the upstairs market. We show that market makers employ “cluster undercutting” practices in the upstairs market, which are based on a notional minimum price increment and resemble an anchoring-and-adjustment effect. In particular, we report that liquidity providers consistently buy just below the implicit minimum price increment and consistently sell just above it. This finding is strongly related to stock-price momentum and periods of increased trade intensity. Overall, this effect has only a weak connection to differences in informed trading and is mostly related to the notional price barriers and resistance levels introduced by the minimum tick size of the order book.

Large trades on the Tunisian Stock Exchange: Downstairs versus upstairs stock markets

This study examines the price impact differences between large trades routed to the central market and blocks traded on the upstairs market on the Tunisian Stock Exchange. The results show that large transactions affect stock prices whether they are routed upstairs or downstairs. In addition, these price impacts are quite different depending on where the execution takes place, especially around large sales. The results of empirical investigations also show that, when upstairs market is governed by too restrictive rules and when brokers do not have the reflex or avoid to trade upstairs, block market does not necessarily improve cost execution.

Stock Market Effects of Institutional Investment Flows: Evidence from Australian Pension Plan Mandate Changes

The rapid growth of pension systems raises the specter of market disruptions from pension plan flows. In particular, appointments and changes of fund managers by pension trustees are accompanied by large intermittent portfolio flows, mostly channeled via the upstairs market. In this article we use pension plan mandate awards and terminations and stock trades initiated by delegated portfolio managers to investigate the stock market impact of shocks resulting from the flow of money from the retirement sector on the main market. Mandate decisions reduce the probability of observing trades. Mandate awards are associated with reduced market impact costs. There is evidence of price pressure from mandate-associated flows.

Does an electronic stock exchange need an upstairs market?

We examine the Paris Bourse, whose electronic limit order market closely resembles the downstairs markets envisioned by theorists, to test several theoretical predictions regarding upstairs trading. We present direct evidence in support of the Grossman (J. Business (1992) 509) prediction that upstairs brokers lower execution costs by tapping into unexpressed liquidity, as actual execution costs upstairs are on average only 20% (35%) as large as they would be if block trades were executed against displayed (displayed and hidden) liquidity in the downstairs limit order book. Consistent with prior analyses, the Paris data also support the Seppi (J. Finance (1990) 73) hypothesis that upstairs brokers certify trades as uninformed. We also find that participants in stocks with less restrictive crossing rules agree to outside-the-quote executions for more difficult trades and at times when downstairs liquidity is lacking. These likely represent trades that could not have been otherwise completed, suggesting that market quality can be enhanced by allowing participants more flexibility to execute blocks at prices outside the quotes.

Use of Different Trading Environments Around Interim Earnings Announcements on the Helsinki Stock Exchange

This paper tests the hypothesis that an anticipated information event affects the use of trading venues. Data from the Helsinki Stock Exchange are used where an upstairs market co–exists with a downstairs market. Trades are classified also as in-house trades and externalized trades. This paper suggests that interim earnings announcement affects where trades are executed. The results indicate that an anticipated announcement increases downstairs trading before the announcement event. Correspondingly trades in the upstairs market tend to decrease before the announcement. After the announcement upstairs trading recovers. Furthermore, the empirical findings suggest that the in-house trades in the upstairs market are positively related to the liquidity and volatility during the pre-announcement period. After the announcement the volatility association changes resulting in increased downstairs trading with high volatility. The results suggest that after the announcement trades are more information-motivated and high volatility is associated with a larger proportion of downstairs trading.

Are Upstairs Markets Pareto Improving?

We examine the price impact cost of block trades across three trading mechanisms: the upstairs market, a crossing network system, and the limit order book. While, unsurprisingly, both the upstairs market and crossing system provide lower price impact costs for block trades than downstairs, using unique exogenous measures of market access we find no evidence that competition from these external markets has an adverse affect. Thus despite the threat that they drain liquidity and cream-skim to harm the main market, these alternative trading mechanisms are Pareto-improving for all investor classes and market participants regardless of which market is the major focus.

Trading and Pricing in Upstairs and Downstairs Stock Markets

We provide empirical evidence on the economic benefits of negotiating trades in the upstairs trading room of brokerage firms relative to the downstairs market. Using Helsinki Stock Exchange data, we find that upstairs trades tend to have lower information content and lower price impacts than downstairs trades. This is consistent with the hypotheses that the upstairs market is better at pricing uninformed liquidity trades and that upstairs brokers can give better prices to their customers if they know the unexpressed demands of other customers. We find that these economic benefits depend on price discovery occurring in the downstairs market. Copyright 2002, Oxford University Press.

Upstairs Market for Principal and Agency Trades: Analysis of Adverse Information and Price Effects

ABSTRACTThis paper directly tests the hypothesis that upstairs intermediation lowers adverse selection cost. We find upstairs market makers effectively screen out information‐motivated orders and execute large liquidity‐motivated orders at a lower cost than the downstairs market. Upstairs markets do not cannibalize or free ride off the downstairs market. In one‐quarter of the trades, the upstairs market offers price improvement over the limit orders available in the consolidated limit order book. Trades are more likely to be executed upstairs at times when liquidity is lower in the downstairs market.

Internalization and stock price clustering: Finnish evidence

Internalization, the practice of brokers executing trades in-house, is a significant phenomenon in the Helsinki Stock Exchange. During the continuous trading session, 97.5% upstairs market trades are internalized. The corresponding figure for after-hours upstairs market trades is 73.1%. The prices of internalized trades are somewhat more clustered than the prices of other trades during the continuous trading session, but they are not more clustered than the prices of negotiated trades in the after-hours upstairs market. This suggests that Finnish brokers do not use a more discrete set of prices for internalized trades than for other upstairs trades.