Essays in microstructure of securities markets (Illinois, Ontario)

Using proprietary data and an event unique in the history of financial markets, the first essay studies the value that a specialist system adds vis-à-vis a multiple market maker system. Specifically, it analyzes the “natural experiment” of the institution of a specialist system for equity options on the Chicago Board Options Exchange (CBOE) in the second half of 1999. The extant literature predicts an increase in market quality due to the change to a specialist system on the CBOE. We find support for these hypotheses. We also offer limited evidence of increased competitiveness of the CBOE. The essay also analyzes the possibility of the rise of preferencing arrangements in the options markets.; The second essay contributes towards an understanding of pre-trade transparency by studying the value limit-order traders place on the ability to hide their intentions in an open electronic limit order book. The paper studies the “natural experiment” of the Toronto Stock Exchange disallowing the use of hidden limit orders. The policy change did not have any visible benefits for the market. However, traders who had optimally used the ability to hide size switched to, a conceivably sub-optimal, use of market orders. This would indicate a welfare loss for at least some traders. Since we do not find a corresponding welfare gain for other traders, the results point towards a welfare loss for the market as a whole as a result of the rule change.; The third essay examines the difference in the performance of the informed versus the uninformed limit order flow. To the extent that some investors are better informed than others we should expect to see a difference in the performance of their orders. Our results indicate that institutional limit orders perform significantly better than the limit orders placed by individuals. These results suggest that institutions are better able to predict at least the flow of information and use this knowledge to submit trades, which avoid adverse selection problems commonly associated with limit orders. The results also point to the use of limit orders by informed traders, an area not previously explored in the literature.