Market Liquidity. Theory, Evidence, and Policy OXFORD UNIVERSITY PRESS THIERRY FOUCAULT MARCO PAGANO AILSA ROELL

Transcription

1 Market Liquidity Theory, Evidence, and Policy THIERRY FOUCAULT MARCO PAGANO AILSA ROELL OXFORD UNIVERSITY PRESS

2 CONTENTS Preface xii ' -. Introduction What is This Book About? Why Should We Care? Some Puzzles The Three Dimensions of Liquidity Market Liquidity Funding Liquidity Monetary Liquidity 10 PART ONE Institutions 1 Trading Mechanics and Market Structure Introduction Limit Order Markets and Dealer Markets Limit Order Markets Dealer Markets Hybrid Markets Market Transparency Does Market Structure Matter? Evolution of Market Structure Who Makes the Rules? Competition between Exchanges Automation Further Reading Exercises 44 2 Measuring Liquidity Introduction Measures of the Spread The Quoted Spread The Effective Spread 50

3 CONTENTS The Realized Spread Other Measures of Implicit Trading Costs Volume-weighted Average Price Measures Based on Price Impact Non-trading Measures Measures Based on Return Covariance Implementation Shortfall Hands-on Estimation of Transaction Costs Further Reading Appendix Exercises 72 Order Flow, Liquidity, and Securities Price Dynamics Introduction Price Dynamics and the Efficient Market Hypothesis Price Dynamics with Informative Order Flow The Glosten-Milgrom Model The Determinants of the Bid-Ask Spread How Do Dealers Revise their Quotes? Price Discovery The Implications for Price Movements and Volatility Price Dynamics with Order-Processing Costs Bid-Ask Spread with Order-Processing Costs Price Dynamics with Order-Processing and Adverse-Selection Costs Price Dynamics with Inventory Risk A Two-Period Model A Multi-Period Model The dynamics of prices and inventories The Full Picture Further Reading Exercises 123 Trade Size and Market Depth Introduction Market Depth under Asymmetric Information Learning from Order Size Perfectly Competitive Dealers The Informed Trader's Order Placement Strategy Imperfectly Competitive Dealers Market Depth with Inventory Risk 148

4 Contents Perfectly Competitive Dealers Imperfectly Competitive Dealers Further Reading Appendix A Appendix B Exercises Estimating the Determinants of Market Illiquidity Introduction 163 "" " 5.2 Price Impact Regressions Without Inventory Costs With Inventory Costs Measuring the Permanent Impact of Trades Probability of Informed Trading (PIN) Further Reading Exercises 184 PART TWO Market Design and Regulation 6 Limit Order Book Markets Introduction AModelofthe Limit Order Book (LOB) The Market Environment Execution Probability and Order Submission Cost Limit Order Trading with Informed Investors The Design of Limit Order Book Markets Tick Size Priority Rules Hybrid LOB Markets The Make or Take Decision in LOB Markets Risk of Being Picked Off and Risk of Non-Execution Bid-Ask Spreads and Execution Risk Bid-Ask Spreads and Volatility Indexed Limit Orders, Monitoring, and Algorithmic Trading Order Flow and the State of the LOB Further Reading Appendix Exercises 232

5 7 Market Fragmentation Introduction The Costs of Fragmentation Information Effects Risk-sharing Effects Competition among Liquidity Suppliers Fragmentation and the Broker-Client Relationship Liquidity Externalities Liquidity Begets Liquidity 254 "" Low-liquidity Traps The Benefits of Fragmentation Curbing the Pricing Power of Exchanges Sharper Competition among Liquidity Providers Trade-throughs Regulation Regulation NMS MiFID Further Reading Exercises Market Transparency Pre-trade Transparency Quote Transparency and Competition between Dealers Quote Transparency and Execution Risk Order Flow Transparency Post-trade Transparency Revealing Trading Motives Why are Markets so Opaque? Rent Extraction and Lobbying Opacity can Withstand Competition The Bright Side of Opacity Further Reading Exercises 303 CONTENTS PART THREE Implications for Asset Prices, Financial Crises, and Corporate Policies 9 Liquidity and Asset Prices Introduction 307

6 Contents 9.2 Illiquidity and Asset Prices The Illiquidity Premium Clientele Effects Evidence Asymmetric Information, Illiquidity, and Asset Returns Illiquidity Premia in OTC Markets Liquidity Risk and Asset Prices Liquidity and Limits to Arbitrage Risk of Early Liquidation as a Limit to Arbitrage Limited Speculative Capital as a Barrier to Arbitrage Implications for Market Making and Liquidity Crises Correlated Order Flow and Noise Trader Risk Further Reading Appendix. The Derivation of the Search Model Exercises Liquidity, Price Discovery, and Corporate Policies Introduction Market Liquidity and Corporate Investment Market Liquidity and Corporate Governance Price Discovery, Corporate Investment, and Executive Compensation Stock Prices and Investment Allocation Stock Prices and Executive Compensation Corporate Policies and Market Liquidity Listing and Cross-listing 373, ; Designated Market Makers Disclosure policy Capital Structure Further Reading Exercises 386 References 389 Author Index 410 Subject Index 416