Overview

The way in which securities are traded is very different from the idealized picture of a frictionless and self-equilibrating market offered by the typical finance textbook. Market Liquidity offers a more accurate and authoritative take on liquidity and price discovery. The authors start from the assumption that not everyone is present at all times simultaneously on the market, and that even the limited number of participants who are have quite diverse information about the security's fundamentals. As a result, the order flow is a complex mix of information and noise, and a consensus price only emerges gradually over time as the trading process evolves and the participants interpret the actions of other traders. Thus a security's actual transaction price may deviate from its fundamental value, as it would be assessed by a fully informed set of investors. This book takes these deviations seriously, and explains why and how they emerge in the trading process and are eventually eliminated. The authors draw on a vast body of theoretical insights and empirical findings on security price formation that have accumulated in the last thirty years, and have come to form a well-defined field within financial economics known as 'market microstructure.' Focusing on liquidity and price discovery, they analyze the tension between the two, pointing out that when price-relevant information reaches the market through trading pressure rather than through a public announcement, liquidity suffers. The book also confronts many puzzling phenomena in securities markets and uses the analytical tools and empirical methods of market microstructure to understand them. These include issues such as why liquidity changes over time, why large trades move prices up or down, and why these price changes are subsequently reversed, why we see concentration of securities trading, why some traders willingly disclose their intended trades while others hide them, and why we observe temporary deviations from arbitrage prices.

Full Product Details

Author:   Thierry Foucault (Professor of Finance, Professor of Finance, HEC Paris International Business School) ,  Marco Pagano (Professor of Economics, Professor of Economics, University of Naples Federico II) ,  Ailsa Roell (Professor of International and Public Affairs, Professor of International and Public Affairs, Columbia University)
Publisher:   Oxford University Press Inc
Imprint:   Oxford University Press Inc
Dimensions:   Width: 24.20cm , Height: 2.70cm , Length: 16.20cm
Weight:   0.748kg
ISBN:  

9780199936243

ISBN 10:   0199936242
Pages:   448
Publication Date:   04 April 2013
Audience:   Professional and scholarly ,  Professional & Vocational
Format:   Hardback
Publisher's Status:   Active
Availability:   To order  
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Table of Contents

PrefaceIntroduction0.1 What is this book about?0.2 Why should we care?0.3 Some puzzles0.4 The three dimensions of liquidity0.4.1 Market liquidity0.4.2 Funding liquidity0.4.3 Monetary liquidityI Institutions1 Market structure and trading mechanics1.1 Introduction1.2 Limit order markets and dealer markets1.2.1 Limit order markets1.2.2 Dealer markets1.2.3 Hybrid markets1.2.4 Market transparency1.3 Does market structure matter?1.4 Evolution of market structure1.4.1 Who makes the rules?1.4.2 Competition between exchanges1.4.3 Automation1.5 Further reading1.6 Exercises2 Measuring liquidity2.1 Introduction2.2 Measures of the spread2.2.1 The quoted spread2.2.2 The effective spread2.2.3 The realized spread2.3 Other measures of implicit trading costs2.3.1 Volume-weighted average price2.3.2 Measures based on price impact2.3.3 Non-trading measures2.3.4 Measures based on return covariance2.4 Implementation shortfall2.5 Hands-on estimation of transaction costs2.6 Further reading2.7 Appendix2.8 Exercises3 Order flow, liquidity and securities price dynamics3.1 Introduction3.2 Price dynamics and the efficient market hypothesis3.3 Price dynamics with informative order flow3.3.1 The Glosten-Milgrom model3.3.2 The determinants of the bid-ask spread3.3.3 How do dealers revise their quotes?3.3.4 Price discovery3.3.5 The implications for price movements and volatility3.4 Price dynamics with order-processing costs3.4.1 Bid-ask spread with order-processing costs3.4.2 Price dynamics with order-processing and adverse-selection costs3.5 Price dynamics with inventory risk3.5.1 A two-period model3.5.2 A multi-period model3.5.3 The dynamics of prices and inventories3.6 The full picture3.7 Further reading3.8 Exercises4 Trade size and market depth4.1 Introduction4.2 Market depth under asymmetric information4.2.1 Learning from order size4.2.2 Perfectly competitive dealers4.2.3 Informed trader's order placement strategy4.2.4 Imperfectly competitive dealers4.3 Market depth with inventory risk4.3.1 Perfectly competitive dealers4.3.2 Imperfectly competitive dealers4.4 Further reading4.5 Appendix A4.6 Appendix B4.7 Exercises5 Estimating the determinants of market illiquidity5.1 Introduction5.2 Price impact regressions5.2.1 Without inventory costs5.2.2 With inventory costs5.3 Measuring the permanent impact of trades5.4 Probability of informed trading (PIN)5.5 Further reading5.6 ExercisesII Market Design and Regulation6 Limit order book markets6.1 Introduction6.2 A model of the limit order book (LOB)6.2.1 The market environment6.2.2 Execution probability and order submission cost6.2.3 Limit order trading with informed trading6.3 Design of LOB markets6.3.1 Tick size6.3.2 Priority rules6.3.3 Hybrid LOB markets6.4 The make or take decision in LOB markets6.4.1 Risk of being picked off and risk of non execution6.4.2 Bid-ask spreads and execution risk6.4.3 Bid-ask spreads and volatility6.4.4 Indexed limit orders, monitoring, and algorithmic trading6.4.5 Order flow and the state of the LOB6.5 Further reading6.6 Exercises7 Market fragmentation7.1 Introduction7.2 The Costs of fragmentation7.2.1 Information effects7.2.2 Risk-sharing effects7.2.3 Competition among liquidity suppliers7.2.4 Fragmentation and the broker-client relationship7.3 Liquidity externalities7.3.1 Liquidity begets liquidity7.3.2 Low-liquidity traps7.4 The benefits of fragmentation7.4.1 Curbing the pricing power of exchanges7.4.2 Sharper competition among liquidity providers7.4.3 Trade-throughs7.5 Regulation7.5.1 Regulation NMS7.5.2 MiFID7.6 Further reading7.7 Exercises8 Market transparency8.1 Pre-trade transparency8.1.1 Quote transparency and competition between dealers8.1.2 Quote transparency and execution risk8.1.3 Order flow transparency8.2 Post-trade transparency8.3 Revealing trading motives8.4 Why are markets so opaque?8.4.1 Rent extraction and lobbying8.4.2 Opacity can withstand competition8.4.3 The bright side of opacity8.5 Further reading8.6 ExercisesIII Implications for Asset Prices, Financial Crises and Corporate Policies9 Liquidity and Asset Prices9.1 Introduction9.2 Illiquidity and asset prices9.2.1 The illiquidity premium9.2.2 Clientele effects9.2.3 Evidence9.2.4 Asymmetric information, illiquidity and asset returns9.2.5 Illiquidity premia in OTC markets9.3 Liquidity risk and asset prices9.4 Liquidity and limits to arbitrage9.4.1 Risk of early liquidation as a limit to arbitrage9.4.2 Limited speculative capital as a barrier to arbitrage9.4.3 Implications for market making and liquidity crises9.5 Correlated order flow and noise trader risk9.6 Further reading9.7 Appendix. The derivation of the search model9.8 Exercises10 Liquidity, price discovery and corporate policies10.1 Introduction10.2 Market liquidity and corporate investment10.3 Market liquidity and corporate governance10.4 Price discovery, corporate investment and executive compensation10.4.1 Stock prices and investment allocation10.4.2 Stock prices and executive compensation10.5 Corporate policies and market liquidity10.5.1 Listing and cross-listing10.5.2 Designated market makers10.5.3 Disclosure policy10.5.4 Capital structure10.6 Further reading10.7 ExercisesReferencesIndex

Reviews

Market Liquidity by Professors Foucault, Pagano and Roell is a wonderful addition to the literature on how markets work; why, sometimes, they don't work as we might wish; and how this affects regulation and corporate decision making. The book is rich in detail, covering the institutional structure of financial markets and the economic and statistical models we use to understand them. While structured as a textbook, it can be read in different ways. Those less interested in the mathematical details will profit from the beautifully written description of the models, some of which are new, and their economic lessons. * Lawrence R. Glosten, S. Sloan Colt Professor of Banking and International Finance, Columbia University *

<br> Market Liquidity by Professors Foucault, Pagano and Roell is a wonderful addition to the literature on how markets work; why, sometimes, they don't work as we might wish; and how this affects regulation and corporate decision making. The book is rich in detail, covering the institutional structure of financial markets and the economic and statistical models we use to understand them. While structured as a textbook, it can be read in different ways. Those less interested in the mathematical details will profit from the beautifully written description of the models, some of which are new, and their economic lessons. --Lawrence R. Glosten, S. Sloan Colt Professor of Banking and International Finance, Columbia University<p><br> Ailsa, Marco and Thierry need to be commended for writing this important and timely contribution on the topic of liquidity that has not just matured over the past twenty years, but which has in fact taken a center-stage as practitioners, policy-makers and academics use liquidity of markets as a barometer for the 'healthy functioning' of economies. The book is rigorous and precise, which is useful given liquidity has many connotations. I strongly recommend the book to all interested in understanding liquidity. --Viral Acharya, C.V. Starr Professor of Economics, New York University<p><br> This book is a highly readable introduction to market microstructure, emphasizing both practical institutional details and applications of theoretical and empirical research to the real word of trading. It is a not only a useful introduction to market microstructure for practitioners but also a great textbook for students at advanced undergraduate, masters, and even Ph.D. levels. I like in particular the numerous connections the book makes between trading institutions and public policy issues. --Albert Pete Kyle, Charles E. Smith Chair Professor of Finance, University of Maryland<p><br> Drawing on their broad and extensive knowledge of market microstructure

Author Information

Thierry Foucault is Professor of Finance, HEC Paris International Business School. Marco Pagano is Professor of Economics, University of Naples Federico II. Ailsa Roëll is Professor of International and Public Affairs, Columbia University.

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