nep-mst New Economics Papers
on Market Microstructure
Issue of 2023‒05‒08
two papers chosen by
Thanos Verousis

  1. Day Traders, Noise, and Cost of Immediacy By Manoj Dalvi; Prachi Deuskar; Lawrence R. Glosten; Ravi Jagannathan
  2. The Retail Execution Quality Landscape By Dyhrberg, Anne Haubo; Shkilko, Andriy; Werner, Ingrid M.

  1. By: Manoj Dalvi; Prachi Deuskar; Lawrence R. Glosten; Ravi Jagannathan
    Abstract: We identify different roles traders play using data with trader identities for all transactions in SENSEX-index stocks on the Bombay Stock Exchange from January 2005 to December 2011. Individual day traders (IDT) are identified as “noise traders”, who play an important role in the market microstructure literature. We measure the impact of their activity on market liquidity and trading of other market participants. IDT contribute 10% to volume while losing 3.2 bp (73% of the half-spread) on average on trades with others, including proprietary day traders (PDT), the primary intraday-liquidity providers, and longer-term traders. While we find some evidence that supports learning among IDT about their own ability and about how to trade, they continue to participate in the market even after losing for a long period. Instrumental variable regressions show that IDT activity reduces bid ask spread and increases intra-day volatility and total volume traded. The volume traded by PDT and the number of PDT active in the market also increase, but PDT profitability stays unchanged with increased IDT activity. This pattern is consistent with competition among PDT. Our results highlight the importance of IDT’s presence in lubricating financial markets.
    JEL: G14 G15
    Date: 2023–04
  2. By: Dyhrberg, Anne Haubo (Wilfrid Laurier U); Shkilko, Andriy (Wilfrid Laurier U); Werner, Ingrid M. (Ohio State U)
    Abstract: Market observers criticize the practice of retail brokers routing retail orders to wholesalers and argue that retail flow should execute on exchanges. Using comprehensive data, we show that both wholesalers and exchanges have characteristics beneficial for retail orders. Wholesalers provide substantial (significantly beyond de minimis) price improvement, while exchanges offer lower liquidity costs (realized spreads). On balance, price improvement dominates, and wholesaler intermediation saves retail investors close to a billion dollars per month. Four characteristics of the market for retail order flow are inconsistent with wholesaler market power. First, retail brokers reward wholesalers that offer lower liquidity costs with more order flow. Second, the largest two wholesalers charge the lowest liquidity costs. Third, neither a new wholesaler entry nor an increase in retail broker bargaining power reduces liquidity costs charged by wholesalers. Fourth, cross-sectional differences in liquidity costs are driven by proxies for inventory costs.
    JEL: G20 G24 G28
    Date: 2022–12

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