3 - Institutional trading & liquidity Flashcards
Quote driven markets vs order driven markets
In pure quote driven markets, public traders cannot arrange trades among themselves
In order driven auction market, all traders issue orders to the exchange
NYSE
- Largest stock exchange in world
- Prior to 2006, most trades conducted on floor by trading crowd
- One specialist for each stock
- Affirmative obligations to offer liquidity: traders of last resort
- Negative obligations: yield to public orders
Specialists maintained a book containing all unexecuted securities, has significant trading advantages relative to other market participants
House Broker (Commission brokers)
- Represent brokerage houses and deal with public and handle orders off the floor
- Nowadays handle large and complex executions needed by institutional customers
Independent Brokers
Known as $2 brokers or broker’s broker
Floor traders (Competitive Traders)
They trade in stocks on the floor for an account in which there is an interest
2006 NYSE was demutalised and merged with Archipelago: role of specialist passed on to designated market makers (DMMs)
DMMs no longer possess trading advantages as they have no special access to order books
SuperDOT trading system is replaced by NYSE super display book system (SDBK) for routing and processing orders
Customers able to execute orders in as quickly as 5 milliseconds
No longer needed to present orders at trading post by a commission broker
Floor trading has diminished significantly since the merger
DMMs have been involved in less than 1 in 30 transactions
- 1 in 7 in 2002
Alternative Trading Systems (ATS)
Trading venue that is not registered with SEC as an exchange
It centralizes, crosses, matches and executes trading interest
- Provides electronic forums for linking dealers with each other and with institutional investors
Types of ATS
- Electronic communication networks (ECNs)
- E.g instinet, archipelago
- Dark pools and “crossing networks”
- Internalization crossing networks
- voice-brokered third party matching
Trading on ASX
Centralized limit order book
No DMMs, no specialists
Liquidity:
Refers to an asset’s ability to be easily purchased or sold without causing significant change in the price of an asset
- Assets can be easily traded with low transactions costs at any time with little impact on the asset’s price
Black (1971) liquidity:
- Always bid and asked prices for the investor who wants to buy or sell small amount of stock immediately, spread is small
- Investor who buy or sell large amount of stock, in absence of special information, can do so over long period of time at a price not very different from current price
- Investor can buy or sell large blocks of stock immediately but at a premium or discount that depends on size of the block
A market is liquid if:
uninformed traders can quickly buy or sell large size when they want at a low transaction cost
Kyle (1985) liquidity dimensions:
- Width: the size available at a given cost
- Depth: time that passes before traders recognize uninformed traders have caused prices to change
- Resiliency: cost per unit
Institutional investors:
mutual funds, pension funds, life insurance companies, trust departments of banks & investment companies