8284 - INFORMATION AND THE ARCHITECTURE OF FINANCIAL MARKETS

The objective of this course is to provide a comprehensive guide to the theoretical and empirical works developed in market microstructure. Market microstructure is the study of the pricing process under explicit trading rules.  While most of financial economics abstracts from the mechanic of trading, the microstructure literature studies how different trading mechanisms affect the price formation process.  Therefore, contrary to the standard asset pricing approach, this field of research assigns a role to transaction costs, asymmetric information and agents' strategic behaviour.

The course comprises three sections.  Firstly, the core features of the financial markets organization will be thoroughly described; then, attention will be focused on the most popular microeconomic models with asymmetric information to show how techniques of microeconomic analysis can be deployed in the context of financial markets for evaluating both regulatory actions and market designs.  Finally, the most recent results from empirical research in microstructure will be used to study the sources and the consequences of transaction costs.  Transaction costs are due to frictions which affect the immediacy of trading. Understanding the sources of transaction costs is important for policy, and understanding the sources of frictions is important  for asset pricing.

The course will end with an overview of high frequency datasets.

Institutional Organization of Financial Markets

• Market structures, market participants, orders and order properties.
• The working of different market models: trading rules (order precedence and trade pricing rules) and price discovery.  Centralization vs fragmentation of trading.
• Competition in market design: internalization, preferencing and best execution.
  

Market Microstructure Theory

• Information  based models:
• Auction market -  price discovery and strategic market participants.
• Dealer market - sequential trading models.
• Inventory based models.
• A model of limit order book.
  

Empirical Market Microstructure

• Empirical models for estimating transaction costs.
• Determinants of the bid-ask spread (inventory risk, free-trading option, adverse selection).
• Implications of market microstructure for price dynamics.
• Evidence on the bid-ask spread and its sources.
• Price effects of trading.

The exam will be in writtent form and only with a general exam at the end of the course. Further details will be discussed during the course.

A reading list will be provided at the beginning of the course.