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Market Microstructure Daniel Sungyeon Kim Lecture 05. Order-driven Markets Order Precedence. Q: What are order precedence rules ?. More on Order Precedence. Q: Why use any rule other than price priority ?. More on Order Precedence. Before 1997, the tick size was wide = $1/8 = 12.5 cents

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Market microstructure daniel sungyeon kim lecture 05

Market MicrostructureDaniel Sungyeon KimLecture 05

Order driven markets order precedence
Order-driven Markets Order Precedence

Q: What are order precedence rules?

More on order precedence
More on Order Precedence

Q: Why use any rule other than price priority?

More on order precedence1
More on Order Precedence

Before 1997, the tick size was wide = $1/8 = 12.5 cents

From 2001 forward, the tick size has been narrow = 1 cent

Q: Are secondary order precedence rules more important with a wide tick size or a narrow tick size?

Size priority
Size priority

  • Explanation:

  • All types of products have segments (soft drinks: regular vs. diet; caffeine vs. no caffeine, etc.)

  • Providing better treatment of large institutional trades attracts that segment

    • NYSE emphasizes serving big orders from institutional traders

    • National Exchange services third market dealers

    • Electronic Communication Networks (ECNs) service day traders

    • Etc.

More on order precedence2
More on Order Precedence

  • Q: What is a uniform pricing rule?

  • Q: What is a discriminatory pricing rule?

Angel harris and spatt
Angel, Harris, and Spatt

Executive summary highlights:

Shift from “human-intermediated markets” (floor or phone) to “computer-intermediated markets” (electronic)

Rise of new trading platforms with different bus. models

Rise of high-frequency traders and algorithmic trading

Growth in trading volume

Decline in spreads and commissions

Smoothly handled the volatility and volume of the 2008 financial crisis

Cost of trading is low in the US compared to the rest of the world

Equity share volume
Equity Share Volume

What do we see?

Median s p 500 spread
Median S&P 500 Spread

Downward trend in spreads for most active stocks

Majority of stocks trade at a one-cent spread!

Median russell 2000 spread
Median Russell 2000 Spread

Downward trend has not been uniform for less active stocks

Vix index of volatility
VIX Index of Volatility

Shows short-lived volatility events:

2008 Financial crisis

2003 Run up to Iraq war

Median s p 500 and russell 2000 spread vix
Median S&P 500 and Russell 2000 Spread / VIX

Spreads are partially driven by volatility

VIX is measure of volatility

Spread / VIX removes the impact of volatility

 can see a downward trend once volatility is removed

Median displayed depth
Median Displayed Depth

What do we see here?

Doubled in the last 5 years


What has happened to commissions?

Trade size
Trade Size

Why is the trade size dropping?

Large trades are being cut up into smaller trades to reduce the cost

Average quotes per minute
Average Quotes per Minute

More quotes per minute due to:

More volume  more quote updates as depth gets depleted or replenished

Decrease in trade size: 10,000 shares desired divided into 5 orders of 2,000 shares each

Q: Why would there be a spike in number of quotes during the financial crisis?

Market order execution speed
Market Order Execution Speed

NYSE Floor Trade = 20 seconds

NYSE Electronic Trade = 1 second

NASDAQ Telephone Trade = 10 seconds

NASDAQ Electronic Trade = 1 second

Increase in execution speed as trading shifts from floor/telephone to electronic

Cancellation execution ratio
Cancellation / Execution Ratio

This refers to non-marketable limit orders [market orders or marketable limits get executed immediately, so no chance to cancel them]

New info and/or prices change  Cancel your limit order and resubmit at an update price

More quotes per minute  more cancels per execution

Nyse listed market share
NYSE-listed Market Share

Regulation NMS in 2005 freed electronic trading platforms to compete with NYSE

It requires an exchange to reroute an order to an electronic exchange (“fast market”) that offers a better price, but the exchange can go ahead and execute a trade while ignoring a potential better price on a floor-based exchange (“slow market”)

Allows customers to choose speed over a potential better price

 key that ignited massive competition by electronic exchanges

“Other” category includes internalization and dark pool trades

Nasdaq listed market shares
NASDAQ-listed Market Shares

NASDAQ historically replied on Dealers and telephone trades

1989 added SOES to autoex on Dealers

2002 added SuperMontage which allowed autoex of market order and limit order = “matching”

2005 acquired ECNs: iNet and Brute

Hendershott moulton
Hendershott & Moulton

  • Background: in2000 NYSE added Automatic execution (“Direct+”) = true electronic trading, but several restrictions:

    • Max order size = 1,099 shares

    • Only marketable limit orders

    • 30 second rule for repeat executions = 30 second waiting time from one order to the next

    • Limited toexecution at best bid or ask  not allowed to “walk up the book”

Nyse hybrid market
NYSE “Hybrid Market”

Q: How did Hybrid Market expand automatic execution?

More on nyse hybrid
More on NYSE “Hybrid”

  • Adding “Liquidity Replenishment Points” = 10 cents apart

  • An order can walk up the limit order book, but stops at liquidity replenishment point

  • Automatic execution  30.07, 30.08, 30.09  stops at 30.10 – only floor trading allowed

  • NYSE is deliberately slowing down the trading process to allow participants to replenish the limit order book


Q: What do we see in Figure 2?

Floor activity vs hybrid activation1
Floor Activity vs. Hybrid Activation

Q: What do we see in Figure 3?

Effective spreads1
Effective Spreads

Q: What do we see in Figure 5?

More on difference in spreads
More on Difference in Spreads

  • (Purple) NYSE Eff Spread – matching NASDAQ Eff Spread

  •  rise on day 0

  • (Dashed green) NYSE Quoted Spread – matching NASDAQ Quoted Spread

  •  rise on day 0

  • Hybrid  higher cost

More on pre and post hybrid
More on Pre and Post Hybrid

  • Q: What do we see in Table 3?