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Chapter 5 Market Structures

Chapter 5 Market Structures. Trading sessions. Trades take place during trading sessions . Continuous market sessions Call market sessions. Continuous markets. Traders may trade at anytime while the market is open. Traders may continuously attempt to arranger their trades.

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Chapter 5 Market Structures

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  1. Chapter 5 Market Structures

  2. Trading sessions • Trades take place during trading sessions. • Continuous market sessions • Call market sessions

  3. Continuous markets • Traders may trade at anytime while the market is open. • Traders may continuously attempt to arranger their trades. • Dealer markets or quote driven markets are, by definition, continuous markets.

  4. Pros and cons of continuous markets • Pros for continuous markets • Traders can arrange their trades whenever they want. • Information may be incorporated very fast into prices. • Cons for continuous markets • more volatile

  5. Call markets • Traders may trade in call markets only when the market is called. • You may have all securities called at the same time or only some. The market may be called several times per day. • Used to open sessions in continuous markets (Bourse de Paris, NYSE,…). Also used for less active securities, bonds,….

  6. Pros and cons of call markets • Pros for call markets • Focus the attention of traders on the same security at the same time. • Less volatility • Cons for call markets • Information may need a lot of time to be incorporated into prices.

  7. Execution systems • The execution system matches the buyers with the sellers. quote-driven markets order-driven markets brokered markets hybrid markets

  8. Quote-driven dealer markets • In pure quote-driven markets, dealers participate in every trade. • Dealers provide all the liquidity and quote bid and ask prices. Those quotes are firm for some specified size, i.e., the dealers must honor them. • If the investor wants to trade a different size, there will be negotiation between the investor and the dealer.

  9. Buy orders decrease the dealer’s inventory position whereas sell orders increase the dealer’s inventory position. • The dealer can then attract or reject order flow given her inventory position. The bid-ask spread’s placement will then reflect her inventory position.

  10. When the dealer’s inventory position is low, she sets both a high bid price and a high ask price. • When the dealer’s inventory position is high, she sets both a low bid and a low ask.

  11. Examples of Dealer Markets: • NASDAQ • London International Stock Exchange (SEAQ) • OTC Bond Markets • Foreign Exchange Markets

  12. General features of a dealer market • Multiple dealers, geographically dispersed, electronically linked. • No consolidation of trading: No “floor”. • Virtually all customer trades are with a dealer. • The dealer is the intermediary. • Customers rarely trade against other customers. • Dealers trade among themselves. • Regulation and transparency are poor relative to floor markets. • Dealers may compete among themselves, but have a lot of information and market power relative to customers.

  13. Dealer market: NASDAQ/SEAQ • Two or more market makers per stock • Trades were mainly phone negotiated • Roughly 95% of the volume went through MM book • No central limit order book. • Small order execution automated, but not larger orders. • Complete decentralization

  14. Dealer obligations • Provide quotes during trading hours • Offer “best execution” • Report trades in a timely manner • Fair communication

  15. Order-driven markets (Ch. 6) • In an order-driven auction market, all traders issue orders to the exchange. • Buyers and sellers regularly trade with each other without the intermediation of dealers. • But dealers may choose to trade. • Order driven markets may be organized as continuous markets or as call markets.

  16. Brokered markets • Brokers match up buyer and seller. • Search is often required to match buyer and sellers for less liquid items, and for large blocks of securities • Brokers specialize in locating counterparts to difficult orders • Concealed traders • Latent traders

  17. Examples of brokered markets include: • Block trading (stocks and bonds) • Real estate • Business concerns

  18. Hybrid markets Hybrid markets mix aspects of the various structures. • The most common hybrid markets are those with dealer-specialists. • These markets are order-driven auction markets in which the specialist must provide liquidity under some circumstances. • Most US stock exchanges and options exchanges have specialist systems.

  19. Market information systems • It is of utmost important that orders are not lost and that order instructions are understood. • Ticker symbols • Order routing systems • Order presentation systems • Screen-based trading systems – electronic • Messaging systems – private messages

  20. The information created by trading is valuable. • Market data systems report trades and quotes to the public • Markets sell information to data vendors • Data vendors offer broadcast and query services • Broadcast services - Continuous • Price and sale feeds • Ticker tapes • Quotation feeds • Query services – on demand • Transparency is a key feature of markets. • Ex ante vs. ex post transparency

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