UNIVERSITÀ DELLA SVIZZERA ITALIANA MARKET MICROSTRUCTURE AND ITS APPLICATIONS Course goals This course introduces you to market microstructure research. The focus is empirical, though theoretical work will be referenced and occasionally covered in some detail. If you have questions, my contact information is as follows: Aditya Kaul University of Alberta School of Business Edmonton, AB T6G 2R6 Canada Tel. (780) 492-5027 Fax. (780) 492-3325 e-mail: akaul@ualberta.ca References The papers to be covered in class are listed below. Papers marked with an asterisk (*) will not be discussed. Useful references include Market Microstructure Theory by Maureen O Hara, Empirical Market Microstructure: The Institutions, Economics, and Econometrics of Securities Trading by Joel Hasbrouck, and Trading and Exchanges by Larry Harris. If you are interested in the material, you should consider buying one or more of these books. Course coverage and schedule A reading list follows. I may add or remove papers depending on the pace at which we proceed. There are 10 lectures, with each lecture being 3 hours long. I have included material for nine lectures, leaving one lecture of slack. I will discuss the papers to be covered during the first three lectures. We will then rotate through the remaining papers, and you will take responsibility for papers and lead the discussion.
Reading list LECTURE 1 AND LECTURE 2. MICROSTRUCTURE THEORY Diamond, D. and R. Verrecchia [1981], Information Aggregation in a Noisy Rational Expectations Economy, Journal of Financial Economics 9, 221-235. Kyle, A. [1985], Continuous Auctions and Insider Trading, Econometrica 53, 1315-1335. Easley, D. and M. O Hara [1992], Time and the Process of Security Price Adjustment, Journal of Finance 47, 577-605. Admati, A. and P. Pfleiderer [1988], A Theory of Intraday Patterns: Volume and Price Variability, Review of Financial Studies 1, 3-40. *Chan, K. [1993], Imperfect Information and Cross-autocorrelation Among Stock Returns, Journal of Finance 48, 1211-1230. *Holden, C. and A. Subrahmanyam [1992], Long-lived Private Information and Imperfect Competition, Journal of Finance 47, 247-270. *Glosten, L. and P. Milgrom [1985], Bid, Ask and Transaction Prices in a Specialist Market with Heterogeneously Informed Traders, Journal of Financial Economics 14, 71-100. *Grossman, S. and J. Stiglitz [1980], On the Impossibility of Informationally Efficient Markets, American Economic Review 70, 393-408. *Subrahmanyam, A. [1991], Risk Aversion, Market Liquidity, and Price Efficiency, Review Of Financial Studies, 4 417-441. *Seppi, D. [1990], Equilibrium Block Trading and Asymmetric Information, Journal of Finance 45, 73-94. *Madhavan, A. and S. Smidt [1991], A Bayesian Model of Intraday Specialist Pricing, Journal of Financial Economics 30, 99-134. *Kandel, E. and N. Pearson [1995], Differential Interpretation of Public Signals and Trade in Speculative Markets, Journal of Political Economy 103, 831-872. LECTURE 3. MICROSTRUCTURE TOOLS Glosten, L. and L. Harris [1988], Estimating the Components of the Bid-ask Spread, Journal of Financial Economics 21, 123-142. Hasbrouck, J. [1991], Measuring the Information Content of Stock Trades, Journal of Finance 46, 179-207. Amihud, Y. [2002], Illiquidity and Stock Returns: Cross-Section and Time Series Effects, Journal of Financial Markets 5, 31-56. 2
*Easley, D., N. Kiefer and M. O Hara [1997], One Day in the Life of a Very Common Stock, Review of Financial Studies 10, 805-835. *Huang, R. and H. Stoll [1997], The Components of the Bid-ask Spread: A General Approach, Review of Financial Studies 10, 995-1034. *Madhavan, A., M. Richardson and M. Roomans [1997], Why do Security Prices Fluctuate? A Transaction-level Analysis of NYSE Stocks, Review of Financial Studies 10, 1035-1064. *Hausman, J., A. Lo and C. MacKinlay [1992], An Ordered Probit Analysis of Transaction Stock Prices, Journal of Financial Economics 31, 319-379. *Foster, D. and S. Vishwanathan [1993], Variations in Trading Volume, Return Volatility, and Trading Costs: Evidence on Recent Price Formation Models, Journal of Finance 48, 187-211. LECTURE 4. MICROSTRUCTURE AND PRICE FORMATION Gerety, M. and H. Mulherin [1994], Price Formation on Stock Exchanges: The Evolution of Trading within the Day, Review of Financial Studies 7, 609-629. Fleming, M. and E. Remolona [1999], Price Formation and Liquidity in the U.S. Treasury Market: The Response to Public Information, Journal of Finance 54, 1901-1915. Barclay, M. and J. Warner [1993], Stealth Trading and Volatility: Which Trades Move Prices?, Journal of Financial Economics 34, 281-306. *Biais, B., P. Hillion and C. Spatt [1999], Price Discovery and Learning During the Preopening Period in the Paris Bourse, Journal of Political Economy 107, 1218-1248. *Kaul, A. [2001], Private information, noisy prices, and trading: A closer look, working paper University of Alberta. *Harris, F. H. deb, T. McInish, G. Shoesmith and R. Wood [1995], Cointegration, Error Correction, and Price Discovery on Informationally Linked Security Markets, Journal of Financial and Quantitative Analysis 30, 563-579. *French, K. and R. Roll [1986], Stock Return Variances: The Arrival of Information and the Reaction of Traders, Journal of Financial Economics 17, 5-26. *Barclay, M., R. Litzenberger and J. Warner [1990], Private Information, Trading Volume and Stock Return Variances, Review of Financial Studies 3, 233-253. LECTURE 5, 6 AND 7. MICROSTRUCTURE, MARKET EFFICIENCY, AND ASSET PRICING Chordia, T., R. Roll and A. Subrahmanyam [2005], Evidence on the Speed of Convergence to Market Efficiency, Journal of Financial Economics 76, 271-292. 3
Andrade, S., C. Chang and M. Seasholes [2008], Trading Imbalances, Predictable Reversals, and Cross-stock Price Pressure, Journal of Financial Economics (forthcoming). Pan, J. and A. Poteshman [2006], The Information in Option Volume for Future Stock Prices, Review of Financial Studies 19, 871-908. Chordia, T., R. Roll and A. Subrahmanyam [2000], Commonality in Liquidity, Journal of Financial Economics 56, 3-28. Acharya, V. and L. Pedersen [2005], Asset Pricing with Liquidity Risk, Journal of Financial Economics 77, 375-410. Easley, D., S. Hvidkjaer and M. O'Hara [2002], Is Information Risk a Determinant of Asset Prices?, Journal of Finance 57, 2185-2221. Avramov, D., T. Chordia and A. Goyal [2006], The Impact of Trades on Daily Volatility, Review of Financial Studies 19, 1241-1277. *Pastor, L. and R. Stambaugh [2003], Liquidity Risk and Expected Stock Returns, Journal of Political Economy 111, 642-685. LECTURE 8. MICROSTRUCTURE AND ANOMALIES Sadka, R. [2006], Momentum and Post-Earnings Announcement Drift Anomalies: The Role of Liquidity Risk, Journal of Financial Economics 80, 309-349. Harford, J. and A. Kaul [2005], Correlated order flow: Pervasiveness, Sources, and Pricing Effects, Journal of Financial and Quantitative Analysis 40, 29-55. Barber, B., T. Odean and N. Zhu [2008], Do Retail Trades Move Markets?, Review of Financial Studies (forthcoming). *Barberis, N., A. Shleifer and J. Wurgler [2005], Comovement, Journal of Financial Economics 75, 283-317. *Chordia, T. and B. Swaminathan [2000], Trading Volume and Cross-autocorrelations in Stock Returns, Journal of Finance 55, 913-935. *Hvidkjaer, S. [2001], A Trade-based Analysis of Momentum, working paper, University of Maryland. *Brown, D. and R. Jennings [1989], On Technical Analysis, Review of Financial Studies 2, 527-552. *Grundy, B. and M. McNichols [1989], Trade and the Revelation of Information through Prices and Direct Disclosure, Review of Financial Studies 2, 495-526. 4
LECTURE 9. MICROSTRUCTURE AND CORPORATE FINANCE Fang, V., T. Noe and S. Tice [2009], Liquidity and Corporate Performance, Journal of Financial Economics (forthcoming). Kamara, A. and J. Koski [2001], Volatility, Autocorrelations and Trading Activity after Stock Splits, Journal of Financial Markets 4, 163-184. Huson, M and G. MacKinnon [2003], Corporate Spinoffs and Information Asymmetry between Investors, Journal of Corporate Finance 9, 481-503. *Angel, J. [1997], Tick Size, Share Prices, and Stock Splits, Journal of Finance 52, 655-681. 5