Asset Returns and the Listing Choice of Firms

We propose a mechanism that relates asset returns to the firm s optimal listing choice. The crucial element in our framework is not a difference in the structure or rules of the alternative markets, but a difference in the return patterns of the securities that are traded on these markets. We use a simple trading model with asymmetric information to show that a stock would be more liquid when it is listed on a market with similar securities, or securities with correlated payoff patterns. We empirically examine the implications of our model using NYSE and Nasdaq securities, and document that the return patterns of stocks listed on the NYSE indeed look different from the return patterns of Nasdaq stocks. Stocks that are eligible to list on another market but do not switch have return patterns that are similar to other securities on their own market and different from securities listed on the other market. We show that the return patterns of stocks that switch markets change in the two years prior to the move in the direction of being more similar to the stocks on the new market. Our results are consistent with the notion that managers choose the market on which to list to maximize the liquidity of their stocks

Information Asymmetry about the Firm and the Permanent Price Impact of Trades: Is there a Connection?

Spread decomposition and variance decomposition methodologies have been developed and used in the literature to obtain measures of information asymmetry about firms. We examine the relation between these market microstructure measures and information asymmetry about the future cash flows of firms. First, to test whether differences in information asymmetry are sufficient to generate differences in the estimated measures, we examine a large cross-section of stocks employing various proxies for uncertainty about future cash flows or informativeness of prices. We Þnd that the market microstructure measures do not consistently reflect uncertainty about future cash flows or relate to the informativeness of prices in a manner that is compatible with their use as proxies for information asymmetry. Second, to test whether changes in information asymmetry about the firm are necessary for the estimated measures to change, we conduct an event study of the Russell 1000 index reconstitution. We find that the information asymmetry measures change around the event despite the fact that Russell 1000 membership is based on market capitalization and therefore the event is not associated with any change in private information about the firms

Individual Investor Sentiment and Stock Returns

This paper investigates a unique dataset that enables us to determine the aggregate buy and sell volume of individual investors for a large cross-section of NYSE stocks. We find that individuals trade as if they are contrarians, and that the stocks that individuals buy exhibit positive excess returns in the following month. These patterns are consistent with the idea that risk-averse individuals provide liquidity to meet institutional demand for immediacy. We further examine the relation between individual investor sentiment and short-horizon (weekly) return reversals that have been documented in the literature. Our results reveal that individual investor sentiment predicts future returns, and that the information content of investor sentiment is distinct from that of past returns or past volume. Furthermore, the trading of individuals predicts weekly returns in the post-2000 era for stocks of all sizes, while past return seems to have lost its predictive power for all but small stocks over the same time period. Lastly, we note that there is very little cross-sectional correlation of our individual sentiment measure across the stocks in our sample

The “Make or Take” Decision in an Electronic Market: Evidence on the Evolution of Liquidity

This paper uses experimental asset markets to investigate the evolution of liquidity in an electronic limit order market. Our market setting includes salient features of electronic markets, as well as informed traders and liquidity traders. We focus on the strategies of the traders, and how these are affected by trader type, characteristics of the market, and characteristics of the asset. We find that informed traders use more limit orders than do liquidity traders. We also find that liquidity provision shifts over time, with informed traders increasingly providing liquidity in markets. This evolution is consistent with the risk advantage informed traders have in placing limit orders. Thus, a market making role emerges endogenously in our electronic markets

Lifting the Veil: An Analysis of Pre-Trade Transparency at the NYSE

This paper investigates an important feature of market design: pre-trade transparency, defined as the availability of information about pending trading interest in the market. We look at how the NYSE’s introduction of OpenBook, which enables traders off the exchange floor to observe depth in the limit order book in real time, affects the trading strategies of investors and specialists, informational efficiency, liquidity, and returns. We find that traders attempt to manage the exposure of their limit orders: the cancellation rate increases, time-to-cancellation shortens, and smaller orders are submitted. The new information OpenBook provides seems to cause traders to prefer managing the trading process themselves, rather than delegating this task to floor brokers. We also show that specialists’ participation rate in trading decreases and the depth they add to the quote goes down, consistent with a loss of their informational advantage or with being "crowded out" by active limit order strategies. We detect an improvement in the informational efficiency of prices after the introduction of OpenBook. Greater pre-trade transparency leads to some improvement in displayed liquidity in the book and a reduction in the execution costs of trades. We find that cumulative abnormal returns are positive following the introduction of OpenBook, consistent with the view that improvement in liquidity affects stock returns

Asset Returns and the Listing Choice of Firms

We propose a mechanism that relates asset returns to the firm s optimal listing choice. The crucial element in our framework is not a difference in the structure or rules of the alternative markets, but a difference in the return patterns of the securities that are traded on these markets. We use a simple trading model with asymmetric information to show that a stock would be more liquid when it is listed on a market with similar securities, or securities with correlated payoff patterns. We empirically examine the implications of our model using NYSE and Nasdaq securities, and document that the return patterns of stocks listed on the NYSE indeed look different from the return patterns of Nasdaq stocks. Stocks that are eligible to list on another market but do not switch have return patterns that are similar to other securities on their own market and different from securities listed on the other market. We show that the return patterns of stocks that switch markets change in the two years prior to the move in the direction of being more similar to the stocks on the new market. Our results are consistent with the notion that managers choose the market on which to list to maximize the liquidity of their stocks

Information Asymmetry about the Firm and the Permanent Price Impact of Trades: Is there a Connection?

Spread decomposition and variance decomposition methodologies have been developed and used in the literature to obtain measures of information asymmetry about firms. We examine the relation between these market microstructure measures and information asymmetry about the future cash flows of firms. First, to test whether differences in information asymmetry are sufficient to generate differences in the estimated measures, we examine a large cross-section of stocks employing various proxies for uncertainty about future cash flows or informativeness of prices. We Þnd that the market microstructure measures do not consistently reflect uncertainty about future cash flows or relate to the informativeness of prices in a manner that is compatible with their use as proxies for information asymmetry. Second, to test whether changes in information asymmetry about the firm are necessary for the estimated measures to change, we conduct an event study of the Russell 1000 index reconstitution. We find that the information asymmetry measures change around the event despite the fact that Russell 1000 membership is based on market capitalization and therefore the event is not associated with any change in private information about the firms

Lifting the Veil: An Analysis of Pre-Trade Transparency at the NYSE

This paper investigates an important feature of market design: pre-trade transparency, defined as the availability of information about pending trading interest in the market. We look at how the NYSE’s introduction of OpenBook, which enables traders off the exchange floor to observe depth in the limit order book in real time, affects the trading strategies of investors and specialists, informational efficiency, liquidity, and returns. We find that traders attempt to manage the exposure of their limit orders: the cancellation rate increases, time-to-cancellation shortens, and smaller orders are submitted. The new information OpenBook provides seems to cause traders to prefer managing the trading process themselves, rather than delegating this task to floor brokers. We also show that specialists’ participation rate in trading decreases and the depth they add to the quote goes down, consistent with a loss of their informational advantage or with being "crowded out" by active limit order strategies. We detect an improvement in the informational efficiency of prices after the introduction of OpenBook. Greater pre-trade transparency leads to some improvement in displayed liquidity in the book and a reduction in the execution costs of trades. We find that cumulative abnormal returns are positive following the introduction of OpenBook, consistent with the view that improvement in liquidity affects stock returns

The Limits of Noise Trading: An Experimental Analysis

In this research we investigate the behavior of noise traders and their impact on the market. We do this in an experimental market setting that allows us to determine not only how noise traders fare in a competitive asset market with other traders, but also how the equilibrium changes if a securities transactions tax (“Tobin tax”) is imposed. We find that noise traders lose money on average: they do not engage in extensive liquidity provision, and their attempt to make money by trend chasing is unsuccessful as they lose most in securities whose prices experience large moves. Noise traders adversely affect the informational efficiency of the market: they drive prices away from fundamental values, and the further away the market gets from the true value, the stronger this effect becomes. With a securities transaction tax, noise traders submit fewer orders and lose less money in those securities that exhibit large price movements. The tax is associated with a decrease in market trading volume, but informational efficiency remains essentially unchanged and liquidity (as measured by the price impact of trades) actually improves. We find no significant effect, however, on market volatility, suggesting that at least this rationale for a securities transaction tax is not supported by our data

The competitive landscape of high-frequency trading firms

Abstract We examine product differentiation in the high-frequency trading (HFT) industry, where the “products” are secretive proprietary trading strategies. We demonstrate how principal component analysis can be used to detect underlying strategies common to multiple HFT firms and show that there are three product categories with distinct attributes. We study how HFT competition in each product category affects the market environment and present evidence that indicates how it influences the short-horizon volatility of stocks as well as the viability of trading venues. Received October 10, 2016; editorial decision September 30, 2017 by Editor Itay Goldstein. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.</jats:p