Essays on Liquidity in Financial Markets

The smooth functioning of financial markets and market efficiency hinge on the ability of market places to limit trading frictions. Liquidity measures the degree of frictions and is an important, if not the most important, measure of market quality. It is a parameter of great relevance for market places wanting to attract order flow from investors, possibly to the detriment of competing trading venues. Liquidity is important for traders since it determines their transaction costs. Besides, investors and firms care about liquidity because of its link to asset pricing. Therefore, the question of how to increase the liquidity of a market place has been widely investigated in recent years. By designing appropriate rules exchanges can help to increase the liquidity of their market and to attract order flow from investors. This dissertation provides new empirical evidence on the determinants of liquidity within a given market and on liquidity migration between competing trading platforms. It concentrates on aspects which have become relevant due to the proliferation of electronic limit order platforms and ongoing changes in market design and political market regulation. In particular, one important market design issue for electronic limit order markets is the question of whether or not to implement hybrid market structures. Chapter 1 examines liquidity provision in a hybrid order driven market where designated sponsors (mandated by Deutsche Börse AG) compete with other designated liquidity providers and the limit order book. It employs panel data analysis in order to cope with an endogeneity problem that is typically encountered by the literature. Results promote the use of multiple designated market makers on electronic limit order platforms. The next chapters analyze liquidity on competing exchanges. Chapter 2 contains the first market microstructure analysis of the world’s largest market for CO2 emission rights. Next to providing an overview of the development of CO2 trading in Europe from 2005 to 2007, Chapter 2 analyzes liquidity and price discovery in this recent market. Results suggest that from a trading perspective, the market has made a lot of progress since its operational start in 2005. The third chapter relates to the recent European MiFID regulation. It analyzes the market entry of the pan-European equity trading platform Turquoise, competing for order flow with primary stock exchanges of 14 European countries. Chapter 3 investigates determinants of success of a new entrant and provides new evidence on whether enhanced competition increases market quality in the primary markets. Overall, by shedding light on determinants of market frictions, the results of this dissertation can give guidance for platform providers, political regulators as well as investors choosing their preferred trading venue. They are thus of interest beyond the academic world. This applies to the findings of Chapter 1 in which evidence is provided that a particular market design can increase liquidity in that market. It also applies to the results of Chapters 2 and 3 which indicate that regarding competition for order flow, changes in market organization have rather weak effects, if any

Market response to investor sentiment : [version January 2011]

This paper reconsiders the effect of investor sentiment on stock prices. Using survey-based sentiment indicators from Germany and the US we confirm previous findings of predictability at intermediate time horizons. The main contribution of our paper is that we also analyze the immediate price reaction to the publication of sentiment indicators. We find that the sign of the immediate price reaction is the same as that of the predictability at intermediate time horizons. This is consistent with sentiment being related to mispricing but is inconsistent with the alternative explanation that sentiment indicators provide information about future expected returns. JEL Classification: G12, G14 Keywords: Investor Sentiment , Event Study , Return Predictabilit

Market response to investor sentiment

Recent empirical research suggests that measures of investor sentiment have predictive power for future stock returns over the intermediate and long term. Given the widespread publication of sentiment indicators, smart investors should trade on the information conveyed by such indicators and thus trigger an immediate market response to their publication. The present paper is the first to empirically analyze whether an immediate response can be identified from the data. We use survey-based sentiment indicators from two countries (Germany and the US). Consistent with previous research we find there is predictability at intermediate time horizons. For the US, however, the predictability disappears after 1994. Using event study methodology we find that the publication of sentiment indicators affects market returns. The sign of the immediate response is the same as that of the predictability over the intermediate term. This finding is consistent with the idea that sentiment is related to mispricing, but is inconsistent with the idea that the sentiment indicator provides information about future expected returns. --Investor Sentiment,Event Study,Return Predictability

Market Response to Investor Sentiment

Recent empirical research suggests that measures of investor sentiment have predictive power for future stock returns over the intermediate and long term. Given the widespread publication of sentiment indicators, smart investors should trade on the information conveyed by such indicators and thus trigger an immediate market response to their publication. The present paper is the first to empirically analyze whether an immediate response can be identified from the data. We use survey-based sentiment indicators from two countries (Germany and the US). Consistent with previous research we find there is predictability at intermediate time horizons. For the US, however, the predictability all but disappears after 1994. Using event study methodology we find that the publication of sentiment indicators affects market returns. The sign of the immediate response is the same as that of the predictability over the intermediate term. This finding is consistent with the idea that sentiment is related to mispricing, but is inconsistent with the idea that the sentiment indicator provides information about future expected returns

Market response to investor sentiment : [This version May 3, 2010]

Recent empirical research suggests that measures of investor sentiment have predictive power for future stock returns over the intermediate and long term. Given the widespread publication of sentiment indicators, smart investors should trade on the information conveyed by such indicators and thus trigger an immediate market response to their publication. The present paper is the first to empirically analyze whether an immediate response can be identified from the data. We use survey-based sentiment indicators from two countries (Germany and the US). Consistent with previous research we find there is predictability at intermediate time horizons. For the US, however, the predictability all but disappears after 1994. Using event study methodology we find that the publication of sentiment indicators affects market returns. The sign of the immediate response is the same as that of the predictability over the intermediate term. This finding is consistent with the idea that sentiment is related to mispricing, but is inconsistent with the idea that the sentiment indicator provides information about future expected returns

Market response to investor sentiment : [This version June 15, 2009]

Recent empirical research suggests that measures of investor sentiment have predictive power for future stock returns at intermediate and long horizons. Given that sentiment indicators are widely published, smart investors should exploit the information conveyed by the indicator and thus trigger an immediate market response to the publication of the sentiment indicator. The present paper is the first to empirically analyze whether this immediate response can be identified in the data. We use survey-based sentiment indicators from two countries (Germany and the US). Consistent with previous research we find predictability at intermediate horizons. However, the predictability in the US largely disappears after 1994. Using event study methodology we find that the publication of sentiment indicators affects market returns. The sign of this immediate response is the same as the sign of the intermediate horizon predictability. This is consistent with sentiment being related to mispricing but is inconsistent with the sentiment indicator providing information about future expected returns. JEL-Classification: G12, G1

Bonn

Tag der mündlichen Prüfung: 30.09.2009to my familyAcknowledgments I owe much gratitude to my supervisor Erik Theissen for his excellent guidance throughout the dissertation. I greatly benefitted from his fruitful advice and insightful comments during countless discussions. Due to his support, I was able to spend several months at the HEC Paris. I would also like to thank Gunther Wuyts who kindly agreed to be part of my dissertation committee. He provided valuable comments and suggestions, especially with respect to the publication of my research. My work has benefitted from productive comments in- and outside the seminars at the University of Bonn and the HEC Paris. In particular, I would like to thank Jörg Breitung for his econometric support and Mark van Achter for constructive discussions and helpful suggestions. Many thanks go to Thierry Foucault for giving me the opportunity to conduct research at the HEC Paris and for stimulating discussions. I took very much pleasure in both the academic and recreational interaction with my fellow graduate students and post-doctoral fellows. In particular, I want to thank Eva Benz. I greatly enjoyed working on our joint research project on carbon markets. I would like to thank Almut Balleer for her continuous help not being limited to econometric issues. Special thanks also go to m