Essays on modern financial markets [electronic resource]

Trading in public equity markets has changed drastically over the past decade: it has become largely automated and orders of magnitudes faster, and it has become spread out across many venues. This dissertation investigates how this transformation has affected market outcomes. Chapter 1 investigates the effect of the proliferation of exchanges on the bid-ask spread. The welfare consequences of increased exchange competition are theoretically ambiguous. While com- petition does place downward pressure on the bid-ask spread, this force may be outweighed by increased adverse selection of liquidity providers that stems from additional arbitrage opportunities. We investigate this ambiguity empirically by estimating key parameters of the model using detailed trading data from Australia. The benefits of increased competition are outweighed by the costs of multi-venue arbitrage. Compared to the prevailing duopoly, we predict that the counterfactual spread under a monopoly would be 23 percent lower. Further, market design variations on the continuous limit order book would eliminate profits from cross-venue arbitrage strategies and reduce the spread by 51 percent. Finally, eliminating off-exchange trades, so-called dark trading, would reduce the spread by 11 percent. Chapter 2 studies the effect of trading speed on market outcomes in a setting where information acquisition is endogenous. An increase in trading speed crowds out information acquisition by reducing the gains from trading against mispriced quotes. Thus, faster speeds have two effects on traditional measures of market performance. First, the bid-ask spread declines, since there are fewer informational asymmetries. Second, price efficiency deteriorates, since less information is available to be incorporated into prices. A general tradeoff exists between low spreads and price efficiency. We characterize the frontier of this tradeoff and evaluate several trading mechanisms within this framework. The prevalent limit order book mechanism generally does not induce outcomes on this frontier. We consider two alternatives: first, a small delay added to the processing of all orders except cancellations, and second, frequent batch auctions. Both induce equilibrium outcomes on this frontier. Chapter 3 investigates the consequences of information arrival on market outcomes in an environment where both high-frequency traders and slow traders engage in liquidity provision. To that end, we develop a model that predicts that fast traders achieve a relative increase in profits obtained from liquidity provision following a news event, which they achieve both by (i) trading smaller volumes at mispriced quotes, and (ii) winning the race to supply liquidity at updated quotes. We find strong support for these model predictions using data from NASDAQ and the Toronto Stock Exchange. The identification strategy is based on an unanticipated news event in which the Twitter feed of the Associated Press falsely reported a successful terrorist attack.

Keywords: Economics.
Advisor: Bresnahan Timothy F. primary advisor. Thesis advisor
Piazzesi Monika primary advisor. Thesis advisor
Levin Jonathan