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Newsletter 1/07 Research and Policy 2 Joint Lunchtime Seminars 10 1 7 The ECB and Its Watchers/ IX 25 Research Articles 2 CFSluncheon 11 CFS Financial Center Index 27 CFSworking papers 6 CFSpresidential lectures 11 Miscellaneous 29 Events 8 CFSresearch conferences 12 Timetable of Forthcoming Events 31 CFScolloquium series 8 The Deutsche Bank Prize 21 Editorial Any time a Euro area head of government several adverse oil shocks lead to the Great will be faced with severe economic recession, Inflation in the United States, the United the temptation will be there to blame overly Kingdom and many other countries. Of course, While Building restrictive interest rates set by the ECB the Great Inflation was no must. Germany, for and to call for changing its mandate. Of example, was able to avoid the sustained rise Europe ... course, as long as other Euro area economies in inflation. The Bundesbank was independent, are performing satisfactorily and remain determined to fight inflation, had a strategy, „And the Goat shall bear upon him all supportive of the ECB’s independence, Euro and, importantly, she could always rely on the their iniquities unto a Land not inhabited.“ inflation aversion (Leviticus 16:22). In this manner, the of the German goat that departs – the (e)scape goat – public. is blamed and punished for the crimes or sufferings of others. The usefulness of such an While the ECB animal should not escape a reformer bent on is similarly inde- changing the French economy but expecting pendent and com- some unavoidable suffering along the way. mitted by treaty Thus, it is easy to understand that French to fight inflation, presidential candidates Ségolène Royal and she cannot count Nicolas Sarkozy repeatedly pointed fingers at on a single natio- the European Central Bank’s “euro fort” policy nal public to during the electoral campaign. stand behind it. As a supra-natio- More recently, President Sarkozy has refrained area central bankers may easily brush this nal institution she conducts monetary policy from further calls for changing the ECB’s policy criticism aside. But what if the economic for a large number of nations whose people mandate. The reactions of other European business cycle in the Euro area becomes more identify with the ECB’s goal of price stability government officials, such as the German, synchronized? Ironically, this is a long-held to very different degrees. Dutch and Austrian finance ministers, made wish by central bankers who hope that the clear that allies for such an initiative would be task of designing a common monetary policy As Chancellor Merkel and President Sarkozy hard to find. Similarly, the lack of a reaction would become easier in such an environment. sit down to discuss how to ensure the long- in foreign exchange markets emphasized However, synchronization would also bring term success of the European Union they may market participants’ belief that the ECB’s along stronger political pressure on the ECB be well advised to guard against long-term independence will remain undisputed for now. in bad economic times. vulnerabilities of its youngest institution. Central bankers taking a longer-term per- To carry the thought experiment further let us Volker Wieland spective, however, should not relax just yet. think of a scenario such as the 1970s, when CFS Director Gesellschaft für Kapitalmarktforschung e.V.: Chairman Board of Trustees: Prof. Dr. Dr. h.c. mult. Otmar Issing; Chairman Managing Board: Dr. Rolf-E. Breuer Center for Financial Studies: President: Prof. Dr. Dr. h.c. mult. Otmar Issing; Directors: Prof. Dr. Jan P. Krahnen, Prof. Volker Wieland Ph.D. (Frankfurt University) Research and Policy | CFS Research Articles CFS Research Articles | Research and Policy Deutsche Börse AG operates the trading Comparing Market Quality ������������������ system Xetra that has also been adopted by the exchanges in Austria and Ireland. Across Exchanges ��� It has attempted mergers with both the ��� ��� ��� February 2007 London Stock Exchange and Euronext, ��� by CFS Program Director Erik Theissen (University of Bonn) and Maria Kasch-Haroutounian (University of Bonn)1 but both attempts failed. Interestingly, during the negotiations with Euronext, ��� Deutsche Börse offered to adopt ��� Exchanges around the world are facing massive structural change. Mergers (like the one between Euronext Euronext‘s trading platform for the � and the NYSE), attempted takeovers, acquisitions of minority stakes, and co-operations are rapidly changing merged entity. ����������� ������������� ��� ��� �������������� the face of the industry. As more and more exchanges are organized in the form of for-profit firms (rather than as mutualized non-profit organizations), both the objectives of exchanges and the nature of competition The two trading systems share many are changing. At the same time, banks and institutional investors are putting pressure on exchange officials to Figure 1 similarities. Most importantly, they are decrease transaction costs. Recently a group of large investment banks has published plans to establish a pan- both anonymous electronic open limit European trading platform for stocks. Such a move would obviously increase the pressure on exchanges to order books, and both have liquidity strive for efficiency. ��������������������� providers (designated market makers referred to as animateurs as well as ��� Given that merging exchanges typically have a significant impact on liquidity, from both markets in question such that designated sponsors in Euronext and ��� ��� ��� have different trading systems, after it is important to control for differing the stocks are as similar as possible with Xetra, respectively) for less liquid stocks. ��� a merger the new entity will have to characteristics. There are two principal respect to these matching criteria. However, closer inspection reveals ��� decide which trading system to adopt approaches to achieving this. The first that there are a number of potentially ��� (or whether to retain both, which is is to analyze identical stocks traded in The idea is simple. If the matching important differences between the tra- likely to reduce the attainable cost both markets, e.g. US stocks, which are procedure is successful (i.e., if the paired ding platforms. These concern, among � ����������� ������������� ��� ��� �������������� reductions). Similarly, an independent also traded on Xetra, or German stocks, stocks are indeed similar with respect other things, trading hours, the existence exchange seeking cooperation with a which are cross-listed on the New York to the criteria used, and if the criteria of intra-daily call auctions, and the rules partner should consider the quality of the Stock Exchange. Although this approach capture all stock-specific characteristics for cross and block trades. Another Figure 2 trading system when choosing between has been used in several empirical studies, that systematically affect liquidity), then potentially important point is that Xetra potential partners. Finally, potential new it has a serious shortcoming. Liquidity differences in liquidity may indeed be faces competition by the Frankfurt Stock entrants need to assess the quality of is positively related to trading volume traced back to the trading system. Exchange and several small regional incumbent exchanges’ trading systems that, in turn, tends to be higher in a exchanges, whereas no such competition before deciding to incur the fixed cost of stock’s home market. Thus, comparing An application: exists in France. Further, there are many entering the market. the liquidity of a stock in its home market Xetra versus Euronext more designated sponsors in Xetra than Since 2000, Erik Theissen has been Professor of with liquidity in another market will there are liquidity providers in Euronext. Business Administration at the Department Against this background, it is important most likely yield the result that liquidity The trading systems Finally, the minimum tick size is different of Economics of the University of Bonn. to measure the quality of a trading system is higher in the home market. In Continental Europe, there are cur- between the two markets. It is always € and to compare different trading systems. rently two major players: Euronext 0.01 in Xetra (for stocks trading at prices Liquidity is usually considered to be The second approach is the matched group and Deutsche Börse. Euronext above € 0.10). In Euronext, on the the most important measure of market samples procedure which has been used was formed in 2000 by a merger between other hand, it is € 0.01 only for stocks quality, and the bid-ask spread is the most extensively in the market microstructure the French Stock Exchange and the trading at prices below €�50. It increases We use three months (65 trading days) of The matching criteria we use are market widely used measure of liquidity. In the literature, e.g. in order to compare the exchanges in Amsterdam and Brussels. to €�0.05 for stocks with prices above data (May, June and July 2002). During capitalization, price level, and volatility. present article, we use this established liquidity of the New York Stock Exchange Euronext has been operating a common €�50, to €�0.1 for stocks with prices our sample period trading hours in Xetra measure of market quality in order to to the liquidity of NASDAQ (e.g. Huang trading platform since 2001. In 2002, above €�100, and to €�0.5 for stocks were longer than those in Euronext. We We use two measures of market quality: address the issue of how to compare
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