The Changing Microstructure of European Equity Markets

In the last decade, the increased competition between European stock exchanges has reduced the cost of trading and increased the variety of trading mechanisms. The London Stock Exchange, which initiated the competition in 1986 by setting up the SEAQ-I market, attracted considerable trading volume in Continental equities in the late 1980s. Later, however, Continental exchanges recovered most of the trading volume from London upon restructuring their auction systems so as to offer very low trading costs, greater transparency and continuous trading via an automated order book. At the same time, the spreads quoted by SEAQ-I dealers increased considerably. Lately, potential competition by continuous auction systems is threatening even the market for British equities, and prompting the London Stock Exchange to replace its former SEAQ system with an automated order book. As in Continental Bourses, this automated auction system is expected to run in parallel with a dealership market for large trades. So trading systems appear to be converging towards a dualistic structure all over Europe. The paper documents these developments, and considers how the competition between European exchanges is likely to evolve and which opportunities and dangers the future may hold for them.

Financial market integration under EMU

The single most important policy-induced innovation in the international financial system since the collapse of the Bretton-Woods regime is the institution of the European Monetary Union. This paper provides an account of how the process of financial integration has promoted financial development in the euro area. It starts by defining financial integration and how to measure it, analyzes the barriers that can prevent it and the effects of their removal on financial markets, and assesses whether the euro area has actually become more integrated. It then explores to which extent these changes in financial markets have influenced the performance of the euro-area economy, that is, its growth and investment, as well as its ability to adjust to shocks and to allow risk-sharing. The paper concludes analyzing further steps that are required to consolidate financial integration and enhance the future stability of financial markets

IPO underpricing and after-market liquidity

The underpricing of the shares sold through Initial Public Offerings (IPOs) is generally explained with asymmetric information and risk. We complement these traditional explanations with a new theory. Investors who buy IPO shares are also concerned by expected liquidity and by the uncertainty about its level when shares start trading on the after-market. The less liquid shares are expected to be, and the less predictable their liquidity is, the larger will be the amount of "money left on the table" by the issuer. We present a model that integrates such liquidity concerns within a traditional framework with adverse selection and risk. The model's predictions are supported by evidence from a sample of 337 British IPOs effected between 1998 and 2000. Using various measures of liquidity, we find that expected after-market liquidity and liquidity risk are important determinants of IPO underpricing, after controlling for variables traditionally used to explain underpricing.liquidity, initial public offering, post-IPO market, after-market trading

The Determinants of Savings: Lessons from Italy

In most of the postwar period Italy featured an abnormally high saving rate, compared to most other industrialized countries. But this is no longer true. Under any definition, in the last decade the Italian saving rate has fallen below the average of the developed economies. Why was the Italian saving ratio comparatively high and why has its decline been so dramatic? In this paper we consider various potential answers to these questions. We particularly focus on the recent slowdown in productivity growth, the development of credit and insurance markets, and the changes in the social security system. In the second part of the paper we use a series of repeated cross-sections from the Survey of Household Income and Wealth in order to check if the macroeconomic explanation for the decline in saving are consistent with microeconomic data.saving

Information Sharing in Credit Markets: A Survey

Information sharing about borrowers' characteristics and their indebtedness can have important effects on credit markets activity. First, it improves the banks' knowledge of applicants' characteristics and permits a more accurate prediction of their repayment probabilities. Second, it reduces the informational rents that banks could otherwise extract from their customers. Third, it can operate as a borrower discipline device. Finally, it eliminates borrowers' incentive to become over-indebted by drawing credit simultaneously from many banks without any of them realizing. Understanding the effects of information sharing also helps to shed light on some key issues in the design of a credit information system, such as the relationship between public and private mechanisms, the dosage between black and white information sharing, and the "memory" of the system. Merging the insights from theoretical models with the lessons of experience, one can avoid serious pitfalls in the design of credit information systems.information sharing, credit markets

Information Sharing, Lending and Defaults: Cross-Country Evidence

Theory predicts that information sharing among lenders attenuates adverse selection and moral hazard, and can therefore increase lending and reduce default rates. To test these predictions, we construct a new international data set on private credit bureaus and public credit registers. We find that bank lending is higher and proxies for default rates are lower in countries where lenders share information, regardless of the private or public nature of the information sharing mechanism. We also find that public intervention is more likely where private arrangements have not arisen spontaneously and creditor rights are poorly protected.information sharing, credit market, default rate

The Welfare Effects of Liquidity Constraints

We analyze the welfare implications of liquidity constraints for households in an overlapping generations model with growth. In a closed economy with exogenous technical progress, liquidity constraints reduce welfare if the economy is dynamically inefficient. But if it is dynamically efficient, some degree of financial repression is required to maximize steady-state utility, even though some generations are hurt in the transition. With endogenous technical progress, financial repression may increase welfare even along the transition path, thus leading to a Pareto improvement. In this case the optimal degree of financial repression increases as the economy grows.saving, liquidity constraints,

Law and Equity Markets: a Simple Model

We analyze how the law and its enforcement affect equity market equilibrium. Improvements in the legal system, while invariably associated with broader equity markets, have different effects on equity returns depending on the institutional change considered and on the degree of international stock market segmentation. The model is useful to interpret the results of recent empirical work, such as La Porta et al. (1997) and Lombardo and Pagano (1999). In particular, it can rationalize the observed cross-country pattern, whereby better institutions are associated both with broader equity markets and higher risk-adjusted returns on equity.law, enforcement, shareholder protection, corporate governance, return on equity

Legal Determinants of the Return on Equity

Recent work documents that better legal institutions are associated with broader equity markets. We investigate whether international differences in legal institutions also help explain the international cross-section of expected stock returns. We document three main regularities. First, total stock market returns are positively correlated with overall measures of the quality of institutions, such as judicial efficiency and rule of law, but have no relationship with measures of shareholder rights, controlling for risk. Second, dividend yields and earning-price ratios also correlate positively with judicial efficiency and rule of law, but negatively with shareholder rights' protection, controlling for risk and expected earnings growth. Thirdly, the excess return on new issues is negatively associated with the quality of accounting standards. We interpret the positive effect of the overall quality of institutions on equity returns as capturing the resulting curtailment of private benefits and increase of profitability, under imperfect international integration of stock markets. The negative impact of shareholders' legal protection and of accounting standards can instead be seen as resulting from the implied reduction in shareholders' auditing and monitoring costs.law, enforcement, shareholder protection, corporate governance, return on equity

The Political Economy of Corporate Governance

We analyze the political determinants of investor and employment protection. Our model predicts that proportional electoral systems are conducive to weaker investor protection and stronger employment protection than majoritarian systems. This prediction is consistent with international panel data evidence. The proportionality of the voting system is significantly and negatively correlated with shareholder protection in a panel of 45 countries, and positively correlated with employment protection in a panel of 21 OECD countries. Also other political variables appear to affect regulatory outcomes, especially for the labor market. The origin of the legal system has some additional explanatory power only for employment protection.political economy, shareholder protection, corporate governance, employment legislation, takeovers, mergers and acquisitions.