week 2 Flashcards
What are the different execution systems?
o Trading rules and trading systems used by a market is defined as its market structure
Determines what traders can do and know in a market
Affects the information asymmetry in the market -> and who trade profitably
Affects trading strategies
Quote Driven Markets
o Dealer is involved in all trades; public traders cannot arrange trades amongst themselves
o Information asymmetry problem
Dealer can choose who they want to trade with / selecting each other
Dealers would not like to trade against informed traders; informed traders will not trade with dealers because informed traders will only trade for profit -> meaning your price is too low
o Public traders cannot arrange trades among themselves
o Dealers supply the liquidity
o Dealers quote their bid and ask prices
Order driven market
o All traders issue orders to the exchange
o Trading without the intermediation of the dealer
Latent traders
o Potential buyers / potential sellers
Brokered markets
o Lots of assets? Go to brokered markets
o Brokered markets are suitable for items that are somehow unique and when dealers are unwilling to hold inventory
o Brokers actively arrange trades in brokered markets; trade initiators contact the broker
o The broker then tries to find counterparties
Hybrid markets
o E.g. NY stock exchange
o Order-driven auction markets in which the specialist must provide liquidity under some circumstances
Order Books
o Manage and store information about standing orders
o Hold extremely valuable information
Front-running opportunities
Arbitrages
o Traders need to leave standing limit orders in the order books for the order-book matching system to work
Some traders do not want to show their orders -> granting option to other traders
Price steps
o Minimum price multiples for a security
o Depends upon the market price of the security
Transparency
o Reporting complete information to the public quickly -> transparent
o Ex Ante Transparent
A market that quickly reports all quotes and orders to the public
o Ex Post Transparent
A market that quickly reports all trades to the public
How are prices and trades determined?
o Order Precedence Rules
o Trade Pricing
Discriminatory pricing Rule
Uniform pricing Rule
Order Precedence Rules
o Facilitate the matching of buy orders with sell orders
o Matching highest ranking buy orders with highest ranking sell orders
Buyer willing to pay as much or more than the seller is willing to receive
o Varies across markets
o Price priority is always the first rule
o Who has priority? IMPORTANT
Buy limit orders with higher prices
Sell limit orders with lower prices
Time Priority Rule
o All orders at a price are ranked by their arrival time
o Order submitted first has the highest priority; if their prices is the same -> refer to bold up top
Tick size affecting the significance of the time precedence rule
o Tick size is large -> more significant of the time precedence rule, e.g. think jumping queue at cinema -> if the tick size ( price to jump is higher) then you will get there earlier
o Affect the time precedence rule, wider tick size -> need to pay more, therefore get there earlier to prevent paying more,
Properties of the price priority rule
o Rule is self-enforcing
o Seller always seeks the buyer bidding the highest price; vice versa
o Secondary rules are not self-enforcing
At a given price, traders do not care about with whom they trade
Trading Pricing Rules
o Pricing rules determine the trade prices
o Vary across exchanges and also across sessions on the same exchange
Call/periodic markets use the uniform pricing rule
• Collect orders for batch processing
Most continuous order-driven trading systems use the discriminatory pricing rule
• Arrange trades continuously as orders arrive
