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Essays on the Microstructure of Stock Markets : Empirical Evidence From DOCTORAL DISSERTATIONS IN ECONOMICS NO. 5 R ANDI N ÆS • Essays on the microstructure of stock markets: Empirical evidence from trading arrangements without dealer intermediation Essays on the microstructure of stock markets: Empirical evidence from trading arrangements without dealer intermediation ISSN 1503-0741 (printed), 0809-652X (online) ISBN 82-7553-309-0 (printed), 82-7553-310-4 (online) Randi Næs NO. 5 Economics Dissertations in Doctoral 33340 The series Doctoral Dissertations in Economics is issued by Norges Bank (Central Bank of Norway) and contains doctoral works produced by employees at Norges Bank, primarily as part of the Bank's research activities. The series is available free of charge from: Norges Bank, Subscription Service E-mail: [email protected] Postal address: PO Box 1179 Sentrum N – 0107 Oslo Norway Previous publication of doctoral dissertations from Norges Bank: (Prior to 2002, doctoral dissertations were published in the series Occasional Papers) Ragnar Nymoen: Empirical Modelling of Wage-Price Inflation and Employment using Norwegian Quarterly Data. (Occasional Papers no. 18, Oslo 1991) Bent Vale: Four essays on Asymmetric Information in Credit Markets. (Occasional Papers no. 20, Oslo 1992) Birger Vikøren: Interest Rate Differential, Exchange Rate Expectations and Capital Mobility: Norwegian Evidence. (Occasional Papers no. 21, Oslo 1994) Gunnvald Grønvik: Bankregulering og bankatferd 1975 – 1991. (Occasional Papers no. 22, Oslo 1994) Ingunn M. Lønning: Controlling Inflation by use of the Interest Rate: The Critical Role of Fiscal Policy and Government Debt. (Occasional Papers no. 25, Oslo 1997) Tom Bernhardsen: Interest Rate Differentials, Capital Mobility and Devaluation Expectations: Evidence from European Countries. (Occasional Papers no. 27, Oslo 1998) Øistein Røisland: Rules and Institutional Arrangements for Monetary Policy. (Occasional Papers no. 29, Oslo 2000) Quaisar Farooq Akram: State Dependent Effects in Labour and Foreign Exchange Markets. (Doctoral Dissertations in Economics no. 1, Oslo 2002) Kai Leitemo: Inflation targeting and monetary policy. (Doctoral Dissertations in Economics No. 2, Oslo 2002) Carl Andreas Claussen: Four essays on the political economy of economic reform (Doctoral Dissertations in Economics No. 3, Oslo 2003) Johannes A. Skjeltorp: Trading in equity markets. A study of individual, institutional and corporate trading decisions (Doctoral Dissertations in Economics No. 4, Oslo 2005) © Norges Bank 2005 The text may be quoted or referred to, provided that due acknowledgement is given to the author and Norges Bank. Views and conclusions expressed in this dissertation are the responsibility of the author alone. The author may be contacted at: [email protected] This book was printed and bound at Lobo Media AS, Oslo. The text was written in 10-point Times by the author. i “outline˙avh” — 2005/8/31 — 13:00 — page i — #1 i i i Essays on the microstructure of stock markets: Empirical evidence from trading arrangements without dealer intermediation by Randi Næs A dissertation submitted for the degree of dr. oecon. at the Norwegian School of Economics and Business Administration i i i i i “outline˙avh” — 2005/8/31 — 13:00 — page ii — #2 i i i To Paula ii DOCTORAL DISSERTATIONS IN ECONOMICS NO. 5. i i i i i “outline˙avh” — 2005/8/31 — 13:00 — page iii — #3 i i i Contents 1 Introduction and overview 1 1 Introduction . 1 2 Two trading methods without dealer intermediation . 5 2.1 Crossing networks . 5 2.2 Electronic limit order markets . 7 3 Essay 1: Equity trading I: To cross or not to cross . 8 4 Essay 2: Equity trading II: Evidence on order submission strategies . 9 5 Essay 3: Order book characteristics and the volume-volatility relation . 10 6 Essay 4: Ownership structure and market liquidity . 10 Bibliography . 12 2 Equity trading by institutional investors: To cross or not to cross 15 1 Introduction . 16 2 Transaction costs in equity markets . 18 2.1 The components of transaction costs . 18 2.2 Transaction costs in a crossing network . 20 2.3 Competition from crossing networks . 22 3 The data . 23 3.1 The trading strategy . 24 4 Measuring transaction costs . 25 4.1 The conditional implementation shortfall cost . 25 4.2 Adverse selection costs in crossing networks . 28 5 Regression analysis . 32 5.1 A regression model on the conditional costs of crossing . 32 5.2 Determinants of the CAR differentials . 35 5.3 A probit model of crossing success . 37 6 Robustness . 39 7 Conclusion . 40 Bibliography . 42 3 Equity trading by institutional investors: Evidence on order submission strategies 45 1 Introduction . 46 2 The data . 49 iii i i i i i “outline˙avh” — 2005/8/31 — 13:00 — page iv — #4 i CONTENTS i i 2.1 The trading strategy . 50 2.2 Robustness . 51 3 Execution probability and primary market liquidity . 52 3.1 Liquidity measures . 53 3.2 Results . 55 4 Limit order simulation . 61 4.1 Literature . 61 4.2 Simulation design . 64 4.3 Measuring trading costs . 66 4.4 Results . 67 5 Conclusion . 73 A Calculation of liquidity and activity measures 75 1 Data issues and filtering . 75 2 Spread measures . 77 3 Volume and depth measures . 78 4 Liquidity ratios and volatility measures . 79 Bibliography . 81 4 Order book characteristics and the volume-volatility relation: Empirical evidence from a limit order market 85 1 Introduction . 86 2 Literature . 89 3 The data . 93 3.1 The Norwegian stock market . 93 3.2 The data sample . 94 3.3 Composition of orders . 97 4 Intraday analysis of the order book . 99 4.1 The shape of the order book . 99 4.2 Intraday Statistics . 103 5 The volume-volatility relation . 108 5.1 The volume-volatility relation in a limit order market . 109 5.2 Volume, volatility and the limit order book . 110 5.3 Daily volatility and order book shape . 113 5.4 Number of trades and order book shape . 119 5.5 Interpretation of the results . 122 6 Conclusions . 125 A Calculation of slope measures and additional estimation results 127 1 Calculating slope measures . 127 2 Balanced sample estimation . 128 3 An alternative slope measure and separating the bid/ask side . 131 Bibliography . 134 iv DOCTORAL DISSERTATIONS IN ECONOMICS NO. 5. i i i i i “outline˙avh” — 2005/8/31 — 13:00 — page v — #5 i CONTENTS i i 5 Ownership structure and market liquidity 137 1 Introduction . 138 2 Literature . 139 3 The Norwegian equity market . 142 3.1 General statistics . 142 3.2 Trading at the OSE . 143 3.3 The corporate governance structure . 143 3.4 Motivation . 144 4 The data sample . 146 4.1 Estimation of adverse selection costs . 146 4.2 Descriptive statistics . 148 5 Results . 151 5.1 A reference model . 151 5.2 Predicted relationships between ownership structure and liquidity . 153 5.3 Outside owner concentration and primary insiders . 154 5.4 Owner types . ..
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