TAILIEUCHUNG - The Microstructure of Stock Markets

For most securities, maturity is the most important determinant of price sensitivity. If a change in interest rates is the same across all maturities, a “parallel” interest rate shift, the price of a long-term security will change more than the price of a short-term one. For example, if interest rates rise 100 basis points, a 30-year, 5 percent coupon Treasury bond would lose nearly 14 percent of its value, while a two-year, 5 percent coupon Treasury note would lose less than 2 percent. Because money market assets mature within one year, they generally have the least price. | The Microstructure of Stock Markets Bruno Biais Larry Glosten and Chester Spatt Revised May 28 2004 Abstract We survey the literature analyzing the price formation and trading process and the consequences of market organization for price discovery and welfare. We develop a uni ed perspective on theoretical empirical and experimental approaches. We discuss the evidence on transactions costs and the price impact of trades and relate the evidence to such frictions as adverse selection inventory costs and market power. We review the extent to which the associated frictions can be mitigated by such features of market design as the degree of transparency the use of call auctions the pricing grid and the regulation of competition between liquidity suppliers or exchanges. Biais is from Toulouse University Glosten is from Columbia University and Spatt is from Carnegie Mellon University. We are grateful for helpful comments from Peter Bossaerts Catherine Casamatta Thierry Foucault Ravi Jagannathan Maureen O Hara Christine Parlour Patrik Sandas and several anonymous referees. The Microstructure of Stock Markets Mark Garman 1976 quite aptly coined the phrase market microstructure as the title of an article about market making and inventory costs. The phrase became a descriptive title for the investigation of the economic forces a ecting trades quotes and prices. Our review will cover not only what research has had to say about the nature of transaction prices but also the broader literature on the interrelation between institutional structure strategic behavior prices and welfare. In perfect markets Walrasian equilibrium prices re ect the competitive demand curves of all potential investors. While the determination of these fundamental equilibrium valuations is the focus of most of asset pricing market microstructure studies how in the short term transaction prices converge to or deviate from long term equilibrium values. Walras himself was concerned about the convergence to .

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