Journal of Financial Markets

Published by Elsevier
Print ISSN: 1386-4181
Publications
This study analyzes how three groups of market participants--insiders, analysts, and all other investors--revised their expectations on New York Real Estate Investment Trusts (REITs) in response to the catastrophic events of September 11, 2001. Our analysis reveals that, on the day when markets reopened, REITs with significant exposure to the New York area outperformed a broad REIT office index by 4.1%. However, we find that, according to several metrics of real market behavior, this anticipated superior performance of New York office properties did not materialize. Further analysis of market participants' activity in office REIT stocks indicates that insiders were the first to lower their expectations (e.g., 99.9% of their trades in REITs with New York exposure were sales in the month following 9/11), followed by analysts (the vast majority of them revised downward their expectations of NY REIT performance in the first weeks of November 2001, albeit heterogeneously so), and finally market prices adjusted to reflect the underlying real market behavior; indeed, abnormal REIT returns had disappeared by mid-November 2001. These dynamics are consistent with theories arguing that the cross-sectional correlation of insiders and analysts' information is an important determinant of trading and pricing patterns in semi-strong efficient market settings.
 
We analyze a simple sunspot model that represents a standard securities market without sidebets on an exogenous sunspot event. The multiple self–fulfilling equilibria that arise in the model are based on investors' uncertainty about other investors' beliefs. Hence, these multiple equilibria are "endogenous sunspots." We show that endogenous sunspots can arise even with complete markets to which all investors have access and homogeneous beliefs, provided the homogeneity is not common knowledge. We also show that endogenous sunspots can produce "pseudo–bubbles" in which the risky asset price is higher (or lower) at all dates than in a no–sunspot equilibrium.
 
In this paper, we collect individual stock prices for NYSE stocks over the period 1815 to 1925 and individual dividend data over the period 1825 to 1870. We use monthly price and dividend information on more than 600 individual securities over the period to estimate a stock price index and total return series that extends virtually to the beginning of the New York Stock Exchange. We use this data to estimate the power of past returns and dividend yields to forecast future long-horizon returns. We find some evidence of predictabiity in sub-periods but little predictability over the long term. We estimate the time-varying volatility of the U.S. market over the period 1815 to 1925 and find evidence of a leverage effect on risk. This new database will allow future researchers to test a broad range of hypotheses about the U.S. capital markets in a rich, untouched sample.
 
Asian stock markets are compared with European markets before and during the 1997 Asian crisis. The clinical issue is whether regional inter-dependence became larger around the crisis, fomenting investor fears of contagion and reducing asset values because of lower diversification potential. Statistical measures are developed to aid in this inquiry. We find that European and East Asian countries were not susceptible to volatility contagion in the pre-crisis era but that susceptibility increased significantly with the onset of the crisis. Covariances, correlations, and volatilities increased from the pre-crisis to the crisis period in both regions, but the percentage increases were much larger in Asia. Diversification potential was better in Asia than in Europe before the crisis; this was reversed during the crisis. The observed decline in diversification potency in Asia is reason enough for large declines in asset values though one cannot prove, of course, that it was the cause rather than the effect of the crisis. Exchange rate volatility played a major role.
 
This study investigates whether net buying pressure contains information, using the intraday data of the KOSPI 200 index option market. We document that the net buying pressure of call (put) options raises the implied volatilities of calls (puts), while the net buying pressure of put (call) options lowers the implied volatilities of calls (puts). Moreover, investors appear to buy call (put) options if the underlying asset price is expected to rise (fall). These relationships between net buying pressure and implied volatility can be accounted for by the direction learning hypothesis, which states that traders with information about the future movements of stock prices trade in the option market before trading in the stock market.
 
We investigate the information cost of stock trading during the 2000 presidential election. We find that the uncertainty of the election induces information asymmetry of politically sensitive firms under the Bush/Gore platforms. The unusual delay in election results creates a significant increase in the adverse selection component of the trading cost of politically sensitive stocks. Cross-sectional variations in bid-ask spreads are significantly and positively related to changes in information cost, controlling for the effects of liquidity cost and stock characteristics. This empirical evidence is robust to different estimation methods.
 
On July 15, 2008, the US Securities and Exchange Commission announced temporary restrictions on naked short sales of the stocks of 19 financial firms. The restrictions offer a unique empirical setting to test Miller's (1977) conjecture that short-sale constraints result in overpriced securities and low subsequent returns. Consistent with Miller's overpricing hypothesis, we find evidence of a positive (negative) market reaction to the announcement (expiration) of the short-sale restrictions. Announcement returns are higher for firms that appear to be subject to more naked short selling in the days immediately preceding the announcement of the restrictions. The restrictions are successful in eliminating naked short sales for the restricted stocks, but naked short sales increase dramatically for a closely matched sample of financial firms during the restricted period. We also find that the restrictions negatively impact various measures of liquidity, including bid-ask spreads and trading volume. From a public policy perspective, our findings suggest that, at a minimum, policymakers should pause when considering further short sale restrictions.
 
Sellers of U.S. equities who have not provided shares by the third day after the transaction are said to have “failed-to-deliver” shares. Using a unique data set of the entire cross-section of U.S. equities, we document the pervasiveness of delivery failures and evidence consistent with the hypothesis that market makers strategically fail to deliver shares when borrowing costs are high. We then show that many firms that allow others to fail to deliver to them are themselves responsible for fails-to-deliver in other stocks. Finally, we discuss the implications of these findings for short-sale constraints, short interest, liquidity, and options listings in the context of the recently adopted SEC Regulation SHO.
 
We study liquidity effects following S&P 500 index revisions. Using a recent sample of S&P 500 additions, we find a sustained increase in the liquidity of the added stocks. Further, the improvement in the liquidity of added stocks is due primarily to a decrease in the direct cost of transacting and a smaller decline in the asymmetric information component. Finally, the event period cumulative abnormal returns for additions are significantly associated with the decrease in the effective spread, particularly the decline in the direct cost of transacting. In contrast, the liquidity of deleted stocks declines over the three months following deletion.
 
We examine the trades of index funds and other institutions around S&P 500 index additions. We find index funds begin rebalancing their portfolios with the announcement of composition changes and do not fully establish their positions until weeks after the effective date. Trading away from the effective date is more prevalent for stocks with lower levels of liquidity and among large index funds, which is consistent with index funds accepting higher tracking error in order to reduce the price impact of their trades. Small and mid-cap funds provide liquidity to index funds around additions, and added stocks with a greater proportion of these natural liquidity providers experience lower inclusion returns.
 
This paper estimates a set of credit spread forecasting models using an 85 year history for AAA and BAA corporate bond yield data for the US. Credit spreads are defined as the corporate bond yield less the 20 year yield on US government bonds and are explained by a set of intuitively appealing financial and economic variables. Initial results relate to the application of cointegration techniques to provide long and short run estimates of the key determinants of credit spreads. The analysis is then extended to allow for an unobservable latent variable Markov Switching specification across two separate states. Finally a deterministic regime model based upon an inflation threshold is estimated demonstrating that key causal relationships exist independently across different inflationary environments.
 
-EFFECT OF NATIONAL ORIGIN ON U.S. DIRECT INVESTMENTS ABROAD (RESULTS FROM MULTI-VARIATE OLS REGRESSIONS)
-EFFECT OF NATIONAL ORIGIN ON U.S. DIRECT INVESTMENTS ABROAD (RESULTS FROM MULTI-VARIATE FIXED EFFECTS PANEL REGRESSION)
We estimate the number of foreign-origin persons in the United States classified by their country of origin from census data in 1970, 1980, 1990 and 2000. We find, both in cross-sectional tests and in panel data tests, that the size of the foreign-origin group from a country living in the U.S. is positively correlated with U.S. investments in that country. This national origin bias is strong for direct (FDI) and modest for indirect (equity holdings) investments. The results continue to hold even after controlling for the “fundamentals” hypothesized to affect foreign investments. The other economic geography variables of a country—physical distance from the U.S., race, language and religion—do not seem to affect US investments in that country.
 
VECMs can detect trades that permanently move the markets in cross-listed stocks. We employ Gonzalo and Granger's (J. Business Econom. Stat. 13 (1995) 1) reduced-rank regressions and QGG test statistic to analyze the common factor weight attributable to three informationally-linked exchanges for DJIA stocks over 1988–1995. We distinguish this error correction approach to trading price adjustment from the information shares approach to quote price leadership. In 1988, a 72.2% mean common factor weight (fNYSE) approximated the NYSE's 86% share of the trades. However, by 1992 fNYSE had declined precipitously for 27 Dow stocks, averaging only 49.6%, despite an unchanged 86% share of the trades. By 1995, the NYSE's common factor weight had recovered, averaging 62.9% on 84% of the trades. We discuss three alternative microstructure-theoretic hypotheses that can confront this evidence.
 
Foreign investors generally underperform domestic investors in trading activities. This study shows that their inferior performance is attributable to non-initiated orders. Foreign investors actually perform better than domestic investors in initiated orders. In addition, their performance is also mixed when trades are classified depending on who the counterparties are. These mixed performances can be explained by neither the information disadvantage hypothesis proposed by [Dvorák, T., 2005. Do domestic investors have an information advantage? Evidence from Indonesia. Journal of Finance 60, 817-839.] nor the poor timing of trade hypothesis suggested by [Choe, H., Kho, B.C., Stulz, R., 2005. Do domestic investors have an edge? The trading experience of foreign investors in Korea. Review of Financial Studies 18, 795-829.]. We propose and confirm that their inferior performance is explained by their aggressive trading behavior. Three metrics we utilize to measure the aggressiveness of foreign investors' trading provide overwhelmingly strong evidence that foreign investors are more aggressive than their domestic counterparts.
 
We reexamine the information content of mutual fund investment objectives to learn whether investors can use them to infer risk. For investment objectives to properly convey risk, risk must be heterogeneous between investment objective groups and homogeneous within them. The present study differs from earlier work in two important ways: (1) it reaches a generally different conclusion about within-objective class fund risk, and (2) it is being done against a backdrop of industry-wide incentive compensation structures that rely on these classifications as proxies for fund volatility. Empirical testing suggests that risk is heterogeneous within groups.
 
Traditional price improvement improperly assesses large orders’ execution quality by ignoring additional liquidity depth-exceeding orders receive at the quoted price and viewing orders that “walk the book” as “disimproved”. Ignoring this additional liquidity is particularly problematic when assessing execution quality in markets with significant non-displayed liquidity. To correct this deficiency, we modify the price benchmark used to determine whether an order is price improved by making the benchmark a function of the order's size relative to the quoted depth. We document that the differences between conventional price improvement and our measure, adjusted price improvement, can be dramatic and show that the difference depends on trading volume, stock price, and volatility.
 
Speeds of adjustment of asset prices towards their intrinsic values will provide direct measures of the degrees of over and underreactions in financial markets. The Amihud and Mendelson (J. Finance 42 (1987) 533) partial adjustment with noise model provides the framework for the analysis presented in this paper. Speed of adjustment coefficient estimators are developed which have advantages over existing estimators in that they can be adjusted for thin trading and have associated sampling distributions. The empirical properties of these estimators are found to be superior to extant estimators. Stock prices are found to be characterised by speeds of adjustment less than complete at short differencing intervals, while evidence of overreaction at longer differencing intervals is found. Large capitalisation stock speeds of adjustment coefficients are found to be higher in most cases than for small capitalisation stocks, even after adjusting for thin trading.
 
This paper examines a two-period model of investment management. Investors reallocate their wealth between two mutual funds managed by different investment advisers after observing the performance of each adviser in the first period. A reputation effect causes one adviser to choose a portfolio in the first period that is extreme given his private information about asset returns. Extreme portfolios are costly for risk-averse advisers and investors because mutual funds are riskier than in one-period or single-adviser settings. Adoption of a performance fee mitigates undesirable reputation effects and results in superior ex ante payoffs to investors.
 
We investigate the effects of the first voluntary shift of a NYSE firm (Aeroflex) to Nasdaq. The switch announcement has resulted in a significant positive abnormal return, in subsequent narrowing of the daily bid–ask spread, and in significant increase of the daily volume. We fail to find evidence that the switch is responsible for making Aeroflex’ stock behave more like a “Nasdaq stock”.
 
Anecdotal evidence suggests and recent theoretical models argue that past stock returns affect subsequent stock trading volume. We study 3,000 individual investors over a 51 month period to test this apparent link between past returns and volume using several different panel regression models (linear panel regressions, negative binomial panel regressions, Tobit panel regressions). We find that both past market returns as well as past portfolio returns affect trading activity of individual investors (as measured by stock portfolio turnover, the number of stock transactions, and the propensity to trade stocks in a given month). After high portfolio returns, investors buy high risk stocks and reduce the number of stocks in their portfolio. High past market returns do not lead to higher risk taking or underdiversification. We argue that the only explanations for our findings are overconfidence theories based on biased self-attribution and differences of opinion explanations for high levels of trading activity.
 
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We document the effects of group affiliation on the initial performance of 2,713 initial public offerings (IPOs) in India under three regulatory regimes during the period 1990–2004. We distinguish between two competing hypotheses regarding group affiliation: the “certification” and the “tunneling” hypotheses. We lend support to the latter by showing that the underpricing of business group companies is higher than that of stand-alone companies. Furthermore, we find that the long-run performance of IPOs, in general, is negative. We also find that Indian investors over-react to IPOs and their over-reaction (proxied by the oversubscription rate) explains the extent of underpricing.
 
The relationship of stock market returns with components of aggregate equity mutual fund flows (new sales, redemptions, exchanges-in, and exchanges-out) is examined. Vector autoregressions and tests of linear feedback show that the flow-return relationship exists solely between returns and exchanges-in and -out. Further, only exchanges-out are responsible for the contrarian flow behavior noted by Warther (1995). The evidence suggests that the various components reflect different investor objectives and information.
 
We find a sizeable positive relation between firm return dispersion and future market-level volatility in U.S. monthly equity returns from 1927 to 1995. This intertemporal relation remains strong when controlling for return shocks in the aggregate stock market, widely used factor-mimicking portfolios, and government bonds. In contrast, the well-known positive relation between market-return shocks and future market-level volatility largely disappears when controlling for firm return dispersion. We also document how firm return dispersion moves with the contemporaneous market return and with economic conditions. Collectively, our evidence suggests that the time variation in firm return dispersion has important market-wide implications.
 
I examine the information content of a limit order book in a purely order-driven market. I analyze how the state of the limit order book affects a trader's strategy. I develop an econometric technique to study order aggressiveness and provide empirical evidence on the recent theoretical models on limit order book markets. My results show that patient traders become more aggressive when the own (opposite) side book is thicker (thinner), the spread wider, and the temporary volatility increases. Also, I find that the buy and the sell sides of the book affect the order submission differently.
 
This paper explicitly models investor behaviour in financial markets allowing for traits linked to a notion of imperfect rationality. We study an extreme form of posterior overconfidence where some risk neutral investors overestimate the precision of their private information. They compete in market orders with another group of informed traders who have rational expectations. The participation of overconfident traders in the market leads to higher transactions volume, larger depth, more volatile and more informative prices. More importantly, such traders may make higher expected profits than rational ones and may even earn more than if they switched to rational behaviour. Their unconscious commitment to aggressive trading offers them a `first mover advantage'. I consider an extension with risk averse market makers and find that the nature of results depends on whether exogenous noise trading exists.
 
This paper demonstrates that short sales are often misclassified as buyer-initiated by the Lee-Ready and other commonly used trade classification algorithms. This result is due in part to regulations which require that short sales be executed on an uptick or zero-uptick. In addition, while the literature considers "immediacy premiums" in determining trade direction, it ignores the often larger borrowing premiums that short sellers must pay. Since short sales constitute approximately 30% of all trade volume on U.S. exchanges, these results are important to the empirical market microstructure literature, as well as to measures that rely upon trade classification, such as the probability of informed trading (PIN) metric.
 
We use university endowment funds to study the relationship between asset allocation decisions and performance in multiple asset class portfolios. Although endowments differ substantially in asset class composition, policy portfolio returns and volatilities are remarkably similar across the sample. The risk-adjusted performance of the average endowment is negligible, but actively managed funds generate significantly larger alphas than passive ones. This is consistent with endowment managers exploiting their security selection abilities by over-weighting asset classes in which they have superior skills. Contrary to both theory and prevailing beliefs, asset allocation is not related to portfolio returns in the cross-section but does indirectly influence performance.
 
This study explains the home bias puzzle by examining the effect of information quality on the asset allocation decisions. Our calibration results based on MSCI data indicate that in order to hedge for the changing quality of the information, when updating their estimates of expected returns of foreign assets, those agents who are partially informed and relatively more conservative will tend to hold fewer foreign assets than completely-informed agents. Furthermore, the magnitude of home bias in the portfolio of partially-informed agents decreases with the precision of their estimates and the instantaneous correlation between the returns of the home and foreign assets.
 
This study analyzes the criteria used to allocate stocks to specialist firms on the NYSE. Non-performance variables play a predominant role in the allocation process, with large specialist firms receiving the majority of new listings. Controlling for size, more-profitable and less-profitable listings tend to be equitably distributed across specialist firms and specialists are more likely to receive allocations if they have not received a recent allocation or have recently had stocks delisted. Preference is also given to specialist firms that already trade other stocks in the same industry or stocks of the same type (funds and non-U.S. securities). Changes to the Allocation Policy in 1997 appear to have resulted in a subset of specialist firms being repeatedly awarded allocations, while others are repeatedly denied allocations.
 
Recent empirical studies use the returns of attribute-sorted portfolios of common stocks as if they represent risk factors in an asset pricing model. If the attributes are chosen following an empirically observed relation to the cross-section of stock returns, such portfolios will appear to be useful risk factors, even when the attributes are completely unrelated to risk. We illustrate this result using a parable and argue that the moral of the story is important in practice.
 
Market integration is studied for Dutch stocks cross-listed at the NYSE. Trading starts in Amsterdam and ends in New York with a one-hour overlap. Both markets are not perfectly integrated in that they can be viewed as one market with the well-documented U-shape in volatility, volume and spread. Increased values for the hour of overlap suggest informed trading. Zooming in on this hour, markets are integrated in that price discovery on both sides of the Atlantic reflects the same underlying, new information. Not consistent across all stocks is the origin of this information, Amsterdam or New York.
 
In assessing the usefulness of the analysts' stock picking advice, the extant literature has largely focused on the profitability of either their stock recommendations or target prices in isolation. In this paper, we examine the profitability of investment strategies that exploit the information analysts convey through revisions in both their stock recommendations and target prices. We find that these strategies significantly outperform the comparable strategies that make use of only one analyst output.
 
We document that within industry relative valuations implicit in analyst target prices do provide investors with valuable information although the implied absolute valuations themselves are much less informative. Importantly, our findings are not merely a small stock phenomenon but apply to the sample of S&P 500 stocks and do not rely on trading at the exact time of announcement. Using a large database of target price announcements from 1997 to 2004, we construct a simple strategy based on target price implied relative valuations and show that the resulting abnormal return is both economically and statistically significant and not easily explained by transaction costs alone.
 
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We provide empirical evidence on the impact of limited market participation on the informational role played by institutions and analysts in the market. Our findings are as follow. First, the price adjustment of stocks that are favored by institutions and analysts and associated with low information set-up costs helps better predict market-wide information. Second, firms that are primarily held by individuals and followed by fewer analysts tend to respond more sluggishly to market-wide information than do firms that are primarily held by institutions and followed by more analysts. This finding is partially attributed to public information generated by the high institutional-ownership and analyst coverage firms with good corporate governance. Third, high institutional-ownership portfolios and high analyst coverage portfolios play a complementary role in predicting market returns. Fourth, there is little systematic difference between high institutional-ownership portfolios and high analyst coverage portfolios in predicting the returns of stocks with different characteristics. Fifth, good market-wide news diffuses more slowly across securities than does bad market-wide news, and this finding primarily occurs in periods of NBER-dated expansions.
 
In this research, we investigate the informational role of financial analysts. Using a trade-based empirical technique, we estimate the probability of information-based trading for a sample of NYSE stocks that differ in analyst coverage. We determine how this probability differs across stocks followed by many analysts, and we investigate whether analysts increase or create the flow of information. We also determine the `normal' level of noise trading in each sample stock, thereby giving us the ability to assess the depth of the market for stocks with differing analysts followings. Our most important empirical result is that the number of financial analysts is not a good proxy for information-based trading.
 
The probability of information-based trading (PIN) introduced by Easley and O’Hara (1987) has been increasingly used in empirical research in finance. We investigate its behavior around a sample of merger and acquisition announcements that took place on Euronext Paris between 1995 and 2000. The behavior of the PIN seems to be in contradiction with clear evidence of information leakages in our sample during the pre-event period. We investigate the reasons for its unusual behavior and raise some concerns about its use as an information-based trading indicator, at least around major corporate events.
 
In a capital asset pricing model (CAPM) framework, Ferguson and Shockley [2003. Equilibrium “anomalies”. Journal of Finance 58, 2549–2580] propose two factors constructed on relative leverage and relative distress, and show that the two factors subsume Fama and French's [1993. Common risk factors in the returns on stocks and bonds. Journal of Financial Economics 33, 3–56] factors constructed on size and book-to-market (BM) in explaining the cross-sectional average returns of the 25 size-BM portfolios. Based on tests on individual securities, we find that all factors fail to fully explain the common asset-pricing anomalies. In the spirit of Merton's [1973. An intertemporal capital asset pricing model. Econometrica 41, 867–887] intertemporal CAPM, we propose an augmented five-factor model, which incorporates Ferguson and Shockley's [2003. Equilibrium “anomalies”. Journal of Finance 58, 2549–2580] factors into the Fama–French three-factor model. The empirical results show that a simple conditional version of the augmented model is able to explain most well-known asset-pricing anomalies.
 
This paper examines the role of carry trade and momentum trading strategies and their implications for the magnitude of the forward premium anomaly. The formal analysis uses a logistic smooth transition regression, with transition variables related to the different currency trading strategies. The hypothesis of uncovered interest parity is found to hold in an upper regime where carry trades appear profitable on the basis of interest differentials and where exchange rate volatility is high. (C) 2011 Published by Elsevier B.V..
 
We examine the effects of the removal of broker identifiers from the central limit order book of the Australian Stock Exchange. We find that spreads and order aggressiveness decline, and order book depth increases, with the introduction of anonymous trading. This is consistent with the hypothesis that limit order traders are more willing to expose their orders when they can do so anonymously. Anonymous markets attract order flow from non-anonymous substitute markets, but this effect is only seen in large stocks. Our results suggest that exchanges operating in fragmented markets should consider anonymous trading to improve price competition and liquidity, although some of these benefits may be significant only if the stocks are sufficiently large and liquid.
 
In this paper we empirically analyze whether the degree of trader anonymity is related to the probability of information-based trading. We use data from the German stock market where non-anonymous traditional floor based exchanges co-exist with an anonymous computerized trading system. We use an extended version of the Easley et al. (J. Finance 51 (1996) 1405) model that allows for simultaneous estimation for two parallel markets. We find that the probability of informed trading is significantly lower in the floor based trading system. We further document that the size of the spread and the adverse selection component are positively related to the estimated probabilities of information-based trading.
 
We use the American Stock Exchange's May 1997 market-wide adoption of $1/16 ticks to examine several hypotheses relating to tick size reduction. Specifically, we consider volatility, other aspects of market quality, trader behavior, and specialist profits. The hypothesis that volatility is directly related to tick size is supported by significant decreases in both daily and transitory volatility. We also find that while spreads decline, depths do not. Finally, while we find no significant changes in overall specialist profits, we develop a direct test of changes in professional traders’ activity in ‘stepping ahead of the book’, and find an increase in this behavior.
 
This paper investigates the liquidity of two different electronic trading systems – the APT system at LIFFE and the DTB system. First we describe the different characteristics of the trading systems and give potential reasons as to why they might differ in liquidity. Second we investigate empirically the liquidity provided by the two trading system. The comparison is especially interesting because the Bund Futures instruments traded are identical and the markets are open simultaneously. The intra-day data used in the study is from August 1997 to February 1998. The results show that the APT has smaller spread but the DTB is slightly deeper.
 
The behavior of US closed-end funds is very different from that of the UK funds studied by Gemmill and Thomas (2002). There is no evidence that their discounts are constrained by arbitrage barriers, no evidence that higher expenses increase discounts and no evidence that replication risk increases discounts—but strong evidence that noise-trader risk is priced. The differences between US and UK funds may be due to the fact that small investors dominate US funds while institutional investors dominate UK funds, or because the sample selection method for the UK funds chooses only funds that are relatively easy to arbitrage.
 
We consider a trader who aims to liquidate a large position in the presence of an arbitrageur who hopes to profit from the trader's activity. The arbitrageur is uncertain about the trader's position and learns from observed price fluctuations. This is a dynamic game with asymmetric information. We present an algorithm for computing perfect Bayesian equilibrium behavior and conduct numerical experiments. Our results demonstrate that the trader's strategy differs significantly from one that would be optimal in the absence of the arbitrageur. In particular, the trader must balance the conflicting desires of minimizing price impact and minimizing information that is signaled through trading. Accounting for information signaling and the presence of strategic adversaries can greatly reduce execution costs.
 
We analyze the customer's choice with respect to a limit-order book, a dealership market, and a hybrid market structure that combines the two. The customer's sell order is competed for and divided among a finite number of risk-averse market makers. We present a general characterization of equilibrium in the limit-order book. We show that when the order flow has a linear hazard ratio, the limit order book is preferred by risk neutral customers. However, a risk averse customer will prefer to trade in a dealership market when the number of market makers is large. Further, for risk averse customers, the hybrid market structure can dominate the dealership market and the limit-order book. The results are driven by a tradeoff between two features of the equilibrium demand schedules: a bid-shading effect that operates differently in a limit-order book compared with a dealership market, and a zero-quantity bid–ask spread that is present in the limit-order book only.
 
In this paper, we use intra-day data for all stocks listed on the ISSM and provide new and direct evidence consistent with the tax-loss selling hypothesis. We find that (a) there is abnormal selling pressure prior to the year-end for stocks that have experienced large capital losses in the current and prior years (b) investors delay realizing capital gain by postponing the sale of capital gain stocks until after the new year (c) there is a significant decrease in the average trade size for stocks with large capital losses before the year-end and for stocks with capital gains in the new year, which suggests that individuals, rather than institutional investors, are the major sellers around the year-end (d) the tax-loss selling hypothesis, and not firm size or share price, is the fundamental explanation for abnormal January returns. Further, small or low share priced firms with capital gains do not experience abnormal returns in January. However, conditional on capital losses, small or low share priced firms magnify the turn-of-the-year effect (e) On average, the increase in selling activity adversely affects market liquidity by increasing bid-ask spreads and reducing depths. (f) The tax-loss selling pressure not only causes the price to be at the bid at the year-end, it also temporarily depresses the equilibrium price indicating the short run demand curve is not perfectly elastic (g) the year-end buying activity suggests that large investors buy capital loss stocks prior to the year-end to take advantage of the temporarily depressed price and capital gain stocks after the new year to reinvest the proceeds of the tax-loss selling.
 
For a set of firms with concentrated insider ownership, we find that (a) the bidask spread changes significantly around the board meeting dates, and (b) the actual number of transactions by insiders increases following the board meetings. We also find that there is a statistically significant relationship between spread and the number of insider trades surrounding the board meeting dates. Furthermore, neither an increase in the number of insider transactions nor any significant relationship between insider trading and the spread is observed for the same set of firms around non-board meeting dates.
 
We investigate the cross-section of 256 financial exchanges throughout the world. First, we empirically analyze the country characteristics that are related to having a financial exchange. Second, we investigate the determinants of an exchange's choice of trading mechanism, and third, we examine whether the presence of an exchange in a country impacts the domestic country's economy. We find that the main determinants for an exchange to exist in a country are the size of the economy, trade policy, foreign investment, development of the banking sector and the legal system. Our results show that the choice of trading mechanism depends on the number of assets traded and the legal system. Lastly, we find that the presence of an exchange is associated with a reduction in the growth of the monetary aggregates but is not associated with other measures of domestic growth and productivity.
 
It is common in the literature to treat trading arrangements as exogenous. Yet, the sheer variety of existing arrangements shows that they are in fact subject to choice. This paper presents a formal analysis of endogenous trading arrangements. I show that observed trading arrangements differ by their ability to facilitate trading. I argue that this property must be taken into account when a choice of a trading mechanism is made. I show that as a result, the choice of a trading arrangement depends on the responses of economic agents to specific market conditions. I present the general argument in the context of emerging foreign exchange markets which exhibit a particularly wide cross-sectional variety of actual trading arrangements. Trading arrangements in emerging foreign exchange markets are of three types: auctions, dealer markets, and mixed, auction-dealer combinations. By formally modeling the institutional details of these markets and applying the premise that trading arrangements are endogenous, I show that a trading arrangement can be chosen by rational agents as a best response to alternative market conditions.
 
Top-cited authors
Yakov Amihud
  • New York University
Narayan Y. Naik
  • London Business School
Andrew W Lo
  • Massachusetts Institute of Technology
Dimitris Bertsimas
  • Massachusetts Institute of Technology
Albert Menkveld
  • Vrije Universiteit Amsterdam