Financial market consolidation versus fragmentation: A comparative analysis.
Item
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Title
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Financial market consolidation versus fragmentation: A comparative analysis.
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Identifier
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AAI3037426
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identifier
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3037426
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Creator
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Murphy, Albert Joseph.
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Contributor
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Adviser: Daniel Weaver
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Date
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2002
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Language
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English
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Publisher
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City University of New York.
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Subject
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Economics, Finance
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Abstract
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This dissertation assesses the outcome of attempts to consolidate a financial market. The concepts of security market consolidation and market fragmentation are surveyed. Market fragmentation and segmentation appear to be responses to the diverse needs of investors and are, in some instances, associated with lower trading costs. However some self-regulation and government oversight is necessary to ensure the fair treatment of all market participants. Tests are then developed to assess the impact on market quality of an attempt to consolidate order-flow on the Toronto Stock Exchange (TSE). In particular, on October 26, 1998 the TSE enacted a rule requiring all trades of 5,000 shares or less to either receive price improvement or be routed to the limit-order book for execution. This rule, referred to as the 'Price Improvement Rule', was instituted to address two specific practices believed to undermine the quality of the TSE. Brokers use the price-setting quote information provided by limit orders to cross customer orders against their inventory, a process referred to as 'front running'. This practice effectively isolates limit orders from competitive interaction the wider market and dissuades limit order traders from supplying liquidity. Members also intentionally cross market orders against their own inventory on the limit order book (a practice I term 'internalizing on the book') by timing the entry of a client's order into the limit order book so that it will cross with an order from the member's inventory just entered in the book; or members cross market orders against their own inventory off the limit order book. Such practices are facilitated through the use of increasingly sophisticated Order Management Systems (OMSs) that allow members to select orders according to size, risk and other characteristic, and can result in lower levels of price competition and higher trade execution costs. Alternatively, the use of the OMSs allows more efficient trading. I find that internalization rates increase for small trades (of 1,200 shares or less) at the spread and outside the spread in a sample of presumably dominant, liquid and active stocks, and at the spread in larger samples that include significant numbers of less liquid stocks; price improvement rates increase significantly for two-tick spread trades of 5,000 shares or less, two-tick spread, non-internalized trades, two-tick spread downstairs trades, and declines significantly for 3-or-more tick spread upstairs trades; quoted and effective spreads decline sharply, market depth increases, market volatility declines, and overall market quality improves. Thus, overall, the implementation of the Price Improvement Rule reduced opportunities for profitable front running, restored time priority, and increased price competition and order interaction among market and limit orders. Those results demonstrate that the use of current technology may not, by itself, result in lower trading costs for investors. Some regulation may be needed to pass the savings generated by more efficient trading systems on to clients. This study empirically investigates the outcome of an attempt to reduce the negative effects of internal market fragmentation. It is demonstrated that the findings may not necessarily apply in the case of external market fragmentation.
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Type
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dissertation
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Source
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PQT Legacy CUNY.xlsx
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degree
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Ph.D.
