Two essays on market micro-structure issues

Abstract

In Part One, I investigate whether the new order handling rules implemented on the NASDAQ, in 1997, negatively affected quote competition because of a sustained high level of preferenced trading. With the new rules in place, quote-competition oriented positions made substantial improvement in relative quote competitiveness but did not gain additional share volume. In contrast, preferencing oriented positions were able to maintain share volume with deteriorated relative competitiveness. The consequences are: (i) reduced share volume sensitivity to relative quote competitiveness; (ii) reduced (increased) quote effectiveness for quote-competition (preferencing) oriented positions; and (iii) net entries (exits) of quote-competition (preferencing) oriented positions. Empirical evidence is consistent with these three negative consequences and is robust to different measures of relative quote competitiveness with or without taking into account quote competition from limit orders. These results suggest that more quote competition does not necessarily promote quote competition when non-price based competition strategy, such as preferencing, is available. In Part Two, I examines whether there was a trading volume migration from non-NYSE markets towards the NYSE after decimalization, and finds that the NYSE's percentage share of small size trading volume increased by approximately 20 percentage points between June 2000 and August 2001, across stocks of all market capitalizations. This paper shows that the trading volume migration was the result of decimalization. Empirical evidence suggests that the NYSE gained market share in small size trades after decimalization through two channels. The first is a reduction in preferenced trading; the second is the NYSE's improved relative competitiveness after decimalization. Further investigation reveals that these two channels have different importance for the trading volume migration for large and small capitalization stocks. The reduction in preferenced trading plays a more important role in the trading volume migration for large capitalization stocks; whereas the improvement in the NYSE's relative competitiveness plays a more important role in the trading volume migration for small capitalization stocks.