Syllabus Short Course on Market Microstructure Goethe Universität, Frankfurt am Main August 24 28, 2015

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1 Syllabus Short Course on Market Microstructure Goethe Universität, Frankfurt am Main August 24 28, 2015 Albert S. Pete Kyle University of Maryland Robert H. Smith School of Business This Version: August 3, 2015 This is a nine-hour mini-course on market microstructure, which will consist of three lectures of three hours each. Class will consist of a mixture of lectures and discussion. The subject matter for the course will be mostly theoretical. There will be an emphasis on dynamic programming applications with a continuous-time flavor. My address is [email protected]. The lectures will emphasize my own current and past research. Three good books providing wider coverage of market microstructure are the following: Larry Harris. Trading and Exchanges: Market Microstructure for Practitioners. Oxford University Press, USA, Thierry Foucault, Marco Pagano, and Ailsa Roell. Market Liquidity: Theory, Evidence, and Policy. Oxford University Press, Joel Hasbrouck. Empirical Market Microstructure: The Institutions, Economics, and Econometrics of Securities Trading. Oxford University Press,

2 Albert S. Kyle Market Microstructure Syllabus August 24 28, Trading as a game Dealer markets and organized exchanges as political outcomes: fixed commissions versus dealer intermediation. Trading, clearing, settlement Adverse selection: Treynor model of bid-ask spread Adverse selection and market power Main readings: J. Treynor. The only game in town. Financial Analysts Journal, 51(1):81 83, Reprint of W. Bagehot. The only game in town. Financial Analysts Journal, 27(2):12 22, Treynor used pseudonym Walter Bagehot in original version. Walter Bagehot is the author of Walter Bagehot. Lombard Street: a description of the money market. Project Gutenberg Etext, Albert S. Kyle. Continuous auctions and insider trading. Econometrica, 53(6): , Lawrence R. Glosten and Paul R. Milgrom. Bid, ask and transaction prices in a specialist market with heterogeneously informed traders. Journal of Financial Economics, 14(1):71 100, Rational Expectations, Imperfect Competition, and Smooth Trading Strong and weak rational expectations Competition and imperfect competition Single-price auctions The dynamics of private information Smooth trading, permanent and temporary price impact

3 Albert S. Kyle Market Microstructure Syllabus August 24 28, Main readings: Albert S. Kyle. Informed speculation with imperfect competition. The Review of Economic Studies, 56(3): , Albert S. Kyle, Anna Obizhaeva, and Yajun Wang. Smooth Trading with Overconfidence and Market Power. Technical report, Working Paper, University of Maryland, SSRN-id , Albert S. Kyle, Anna A. Obizhaeva, and Yajun Wang. Beliefs Aggregation and Returns Predictability with Smooth Trading. Technical report, Working Paper, University of Maryland, SSRN-id , July Sanford J. Grossman and Joseph E. Stiglitz. On the impossibility of informationally efficient markets. The American Economic Review, 70(3): , Market Microstructure Invariance, Market Crashes, and High-Frequency Trading Market microstructure invariance. Market Crashes High frequency trading Main readings: Albert S. Kyle and Anna Obizhaeva. Market Microstructure Invariants: Theory and Empirical Tests. Technical report, Working Paper, University of Maryland, SSRN-id , Albert S. Kyle and Anna Obizhaeva. Large Bets and Stock Market Crashes. Technical report, Working Paper, University of Maryland, SSRN-id , Andrei Kirilenko, Albert S. Kyle, Tugkan Tuzun, and Mehrdat Samadi. The Flash Crash: The Impact of High Frequency Trading on an Electronic Market. Technical report, Working Paper, University of Maryland, SSRN-id , 2012.

4 Albert S. Kyle Market Microstructure Syllabus August 24 28, Other Readings Other books and surveys are the following: Maureen O Hara. Market Microstructure Theory. Blackwell Publishing Ltd, Daniel F. Spulber. Market Microstructure: Intermediaries and the Theory of the Firm. Cambridge University Press, Markus K. Brunnermeier. Asset Pricing under Asymmetric Information: Bubbles, Crashes, Technical Analysis, and Herding. Oxford University Press, USA, Andrei Shleifer. Inefficient Markets: An Introduction to Behavioral Finance (Clarendon Lectures in Economics). Oxford University Press, USA, Xavier Vives. Information and Learning in Markets: The Impact of Market Microstructure. Princeton University Press, Franklin Allen and Douglas Gale. Understanding Financial Crises (Clarendon Lectures in Finance). Oxford University Press, USA, John Y. Campbell, Andrew W. Lo, and A. Craig MacKinlay. The Econometrics of Financial Markets, chapter 3: Market Microstructure. Hans R. Stoll. Handbook of the Economics of Finance: Corporate Finance, Volume 1A, chapter 9: Market Microstructure, pages North Holland, David Easley and Maureen O Hara. Handbook of the Economics of Finance: Financial Markets and Asset Pricing, Volume 1B, chapter 17: Microstructure and Asset Pricing, pages North Holland, Bruno Biais, Larry Glosten, and Chester Spatt. Market microstructure: A survey of microfoundations, empirical results, and policy implications. Journal of Financial Markets, 8(2): , N. Barberis and R.H. Thaler. A survey of behavioral finance

5 Albert S. Kyle Market Microstructure Syllabus August 24 28, Y. Amihud, H. Mendelson, and L. Pedersen. Liquidity and asset pricing. Foundation and Trends in Finance, 1: , Other papers are the following: John F. Muth. Rational expectations and the theory of price movements. Econometrica, 29(3): , Sanford J. Grossman and Merton H. Miller. Liquidity and market structure. The Journal of Finance, 43(3): , P. Milgrom and N. Stokey. Information, trade and common knowledge. Journal of Economic Theory, 26(1):17 27, J. Tirole. On the possibility of speculation under rational expectations. Econometrica, 50(5): , 1982 Jr. Lucas, Robert E. Asset prices in an exchange economy. Econometrica, 46(6): , Stephen F. LeRoy. Risk aversion and the martingale property of stock prices. International Economic Review, 14(2): , Eugene F. Fama. Efficient capital markets: A review of theory and empirical work. The Journal of Finance, 25(2): , Eugene F. Fama. Efficient capital markets: Ii. The Journal of Finance, 46(5): , J. Michael Harrison and David M. Kreps. Speculative investor behavior in a stock market with heterogeneous expectations. The Quarterly Journal of Economics, 92(2): , Fischer Black. Noise. The Journal of Finance, 41(3): , Fischer Black. Estimating expected return. Financial Analysts Journal, 51(1): , John Y. Campbell and Albert S. Kyle. Smart money, noise trading and stock price behaviour. The Review of Economic Studies, 60(1):1 34, 1993.

6 Albert S. Kyle Market Microstructure Syllabus August 24 28, Jack Hirshleifer. The private and social value of information and the reward to inventive activity. The American Economic Review, 61(4): , J. Detemple and S. Murthy. Intertemporal asset pricing with heterogeneous beliefs. Journal of Economic Theory, 62(2): , 1994 Martin F. Hellwig. Rational expectations equilibrium with conditioning on past prices: A mean-variance example. Journal of Economic Theory, 26(2): , 1982 Jiang Wang. A model of intertemporal asset prices under asymmetric information. The Review of Economic Studies, 60(2): , Jiang Wang. A model of competitive stock trading volume. The Journal of Political Economy, 102(1): , Jungsuk Han and Albert S. Kyle. Speculative Equilibrium with Differences in Higher Order Beliefs. Technical report, Working Paper, University of Maryland, 2014 Robert M. Townsend. Forecasting the forecasts of others. The Journal of Political Economy, 91(4): , Kerry Back and Shmuel Baruch. Information in securities markets: Kyle meets glosten and milgrom. Econometrica, 72(2): , Kerry Back. Asymmetric information and options. The Review of Financial Studies, 6(3): , Kerry Back. Insider trading in continuous time. The Review of Financial Studies, 5(3): , Kerry Back, C. Henry Cao, and Gregory A. Willard. Imperfect competition among informed traders. The Journal of Finance, 55(5): , Minh Chau and Dimitri Vayanos. Strong-Form Efficiency with Monopolistic Insiders. Review of Financial Studies, 21(5): , Dimitri Vayanos. Strategic trading and welfare in a dynamic market. Review of Economic Studies, 66(2): , 1999.

7 Albert S. Kyle Market Microstructure Syllabus August 24 28, F. Douglas Foster and S. Viswanathan. A theory of the interday variations in volume, variance, and trading costs in securities markets. The Review of Financial Studies, 3(4): , F. Douglas Foster and S. Viswanathan. Variations in trading volume, return volatility, and trading costs: Evidence on recent price formation models. The Journal of Finance, 48(1): , F. Douglas Foster and S. Viswanathan. Strategic trading when agents forecast the forecasts of others. The Journal of Finance, 51(4): , F. Douglas Foster and S. Viswanathan. The effect of public information and competition on trading volume and price volatility. The Review of Financial Studies, 6(1):23 56, F. Douglas Foster and S. Viswanathan. Strategic trading with asymmetrically informed traders and long-lived information. The Journal of Financial and Quantitative Analysis, 29(4): , F. Douglas Foster and S. Viswanathan. Can speculative trading explain the volume-volatility relation? Journal of Business and Economic Statistics, 13(4): , D. Bernhardt and B. Taub. Kyle v. Kyle (85 v.89). Annals of Finance, 2(1):23 38, Albert S. Kyle, Anna A. Obizhaeva, and Tugkan Tuzun. Trading Game Invariance in the TAQ Dataset. Technical report, Working Paper, University of Maryland, Kyoung hun Bae, Eun Jung Lee Albert S. Kyle, and Anna A. Obizhaeva. An Invariance Relationship in the Number of Buy-Sell Switching Points. Technical report, Working Paper, University of Maryland, Torben G. Andersen, Oleg Bondarenko, Albert S. Kyle, and Anna A. Obizhaeva. Intraday Trading Invariance in the E-mini S&P 500 Futures Market. Technical report, Working Paper, 2015.