INTRODUCTION TO MARKET

MICROSTRUCTURE
W H AT I S M A R K E T
MICROSTRUCTURE?
• Trading rules (Example- https://www.nseindia.com/products-services/equity-market-segment)
• Physical layouts (Example- https://www.nseindia.com/trade/platform-services-neat-trading-system)
• Information presentation system
• Information communication system
• How market participants interact
• Safe guards for market
• Circuit Filter/ Price band
• Circuit breaker/Trading halts
TEXTBOOK DEFINITION
• “Market microstructure is the study of financial markets and how they operate. Market
microstructure research primarily focuses on
• the structure of exchanges and trading venues (e.g. displayed and dark),
• the price discovery process,
• determinants of spreads and quotes,
• intraday trading behavior, and
• transaction costs.

Robert Kissell Ph.D, in The Science of Algorithmic Trading and Portfolio Management, 2014
W H AT D O W E T R A D E ?
• Assets: Financial vs real assets???
• Value of asset?
• Information?
WHY WE TRADE?
• For Profits
• For information
• For price discovery
• Others?
HOW AND WHY DO PRICES MOVE?
DIMENSIONS OF MARKET
1. Trading platform
• Manual/semi-manual vs fully automated
• Speed of order submission/execution
• Market integration
• Market stabilizing mechanism
2. Information flow mechanism
3. Traders Interaction
4. Regulatory mechanism
5. Imperfections
• Transaction cost
• Information asymmetry
TYPES OF TRADERS
• Proprietary traders
• Brokers or agency traders
• Dealers
• Hedgers
• Arbitrageurs
• Value investors
• Front runner
T Y P E O F PA R T I C I PA N T S

Source: Larry Harris book

SOME TERMS
• Ask – bid price
• Mid quote /mid price
• Best bid and best ask price
• Bid/ask spread (Best Ask-Best Bid Price)
• Market quotation / Best Bid and Offer (BBO)
• NBBO- National BBO
• Standing/Open, Orders
• Market or Price impact
• Tick size- Uptick, downtick, zero uptick, zero downtick
BLOCK DEALS IN THE SHARE
MARKET
• A block deal can be defined as a single trade or transaction in which more than or equal
to 5,00,000 shares are transacted in terms of quantity or at least Rs.10 crore in value.
• not transacted in the regular trading session, retail investors cannot view block deals; the
volume traded in a block deal does not show up on a price chart.
• There are two block deal windows
• morning block deal window is from 8:45 AM to 9:00 AM.
• afternoon block deal window is from 2:05 PM to 2:20 PM
BULK DEALS IN THE SHARE
MARKET
• Deals involve at least 0.5% of the total listed shares of a company.
• Do not have a special trading window and are carried out during regular trading hours.
• Bulk deals are visible to all market participants, including retail investors.
• The broker who facilitates bulk transactions between investors or institutions must notify
the stock exchanges of the transaction’s details.

• Link- https://www.nseindia.com/report-detail/display-bulk-and-block-deals
LIMIT ORDER BOOK (LOB)
• Orders
PRICES
S C H E M AT I C O F L O B AT S O M E
TIME
CALL AUCTION
PRICE DISCOVERY IN THE ORDER
BOOK
INSIGHTS:
T I C K S I Z E I D E N T I F I C AT I O N
• Lee, C. M., & Ready, M. J. (1991). Inferring trade direction from intraday data. The Journal of
Finance, 46(2), 733-746.
• Finucane, T. (2000). A Direct Test of Methods for Inferring Trade Direction from Intra-Day Data. The
Journal of Financial and Quantitative Analysis, 35(4), 553-576. doi:10.2307/2676255
• Theissen, E. (2001). A test of the accuracy of the Lee/Ready trade classification algorithm. Journal of
International Financial Markets, Institutions and Money, 11(2), 147-165.
• Lee, C., & Watts, E. M. (2018). Tick size tolls: Can a trading slowdown improve price discovery (No.
3732).
• Chung, Kee H., Albert J. Lee, and Dominik Rösch (2020). Tick size, liquidity for small and large orders,
and price informativeness: Evidence from the Tick Size Pilot Program. Journal of Financial
Economics 136, no. 3: 879-899.
TICK SIZE: SOME RESEARCH
• Goldstein, M. A., & Kavajecz, K. A. (2000). Eighths, sixteenths, and market depth: changes in tick size and
liquidity provision on the NYSE. Journal of Financial Economics, 56(1), 125-149.
• Ahn, H. J., Cao, C. Q., & Choe, H. (1996). Tick size, spread, and volume. Journal of financial
intermediation, 5(1), 2-22.
• Schultz, P. (2000). Stock splits, tick size, and sponsorship. The Journal of Finance, 55(1), 429-450.
• Chung, K. H., Lee, A. J., & Rösch, D. (2020). Tick size, liquidity for small and large orders, and price
informativeness: Evidence from the Tick Size Pilot Program. Journal of Financial Economics, 136(3), 879-899.
• Yamamoto, R. (2020). Limit order submission risks, order choice, and tick size. Pacific-Basin Finance
Journal, 59, 101261.
• Eaton, G. W., Irvine, P. J., & Liu, T. (2020). Measuring institutional trading costs and the implications for finance
research: The case of tick size reductions. Journal of Financial Economics.
• Blau, B., & Whitby, R. (2020). Rethinking Decimalization: The Impact of Increased Tick Sizes on Trading
Activity, Volatility, and Price Clustering. Market Microstructure and Liquidity.
AN EXAMPLE- AXISBANK
TYPE OF ORDERS
• Market orders (liquidity taker)
• Limit orders (liquidity provider)
• Stop orders
GENERAL TERMS USED
S U M M A R Y: O R D E R P R O P E R T I E S
TRADING MARKET/SESSIONS
• Continuous Market
• Call Market
• Call vs Continuous Trading Sessions
• Trading Hours
ORDER EXECUTION SYSTEMS
• Quote driven Dealers Market
• Order driven market
W H AT I S M A R K E T Q U A L I T Y ?
• Liquidity
• Transaction cost
• Informative prices
• Volatility
• Trading profits
COVERAGE IN THIS COURSE
Sl. No. Topic Articles/models/specific area
Financial Markets: Traders,
1 O'Hara & Ye (2011)
Orders, and Systems
Recent Innovations in Jain (2005), Madhavan (2000), Forde & Rhydge
2
Financial Markets (2006)
The Garman’s Model, Amihud-Mendelson
3 Inventory Model
Model, Stoll and Huang Model
Kyle's Model, Glosten-Milgrom Model and other
4 Information-Based Models
extension models
Models of the Limit-Order The CMSW Model, Parlour Model, Foucault
5
Markets Model
Empirical Market Roll’s Model, Glosten-Harris Model, Fong,
6
Microstructure Holden , and Trzcinka, 2017, Other models
Flash Crash, Changes in trading structure,
7 Market Imperfections
circuit breakers etc
market efficiency, information
8 HFT and Algo Traders
delay/improvements etc.
Short selling, Dark pools,
9 Subrahmanyam, 2013, Zhu 2014,
Crypto currencies etc.
ABOUT NSE INDIA
M A R K E T S TA B I L I S E R S
• Circuit Breakers
H F T- N E W I N N O VAT I O N S
• Issues emerged with HFT practice across the exchanges
• Algorithmic trading
• Co-location
• Flash crash
• Quote stuffing
• Portfolio revision
• Predatory trading
BROAD MEASURES OF MARKET
QUALITY
• Liquidity
• Price Informativeness
• Volatility
• Transaction Cost
• Trading Profits
QUICK SUMMARY

Market Microstructure: A Survey of

Microfoundations, Empirical Results,
and Policy Implications

Bruno Biais, Larry Glosten and

Chester Spatt
S T R AT E G I C L I Q U I D I T Y S U P P LY

Market Microstructure: A Survey of

Microfoundations, Empirical Results,
and Policy Implications

Bruno Biais, Larry Glosten and

Chester Spatt
S T R AT E G I C L I Q U I D I T Y S U P P LY

Market Microstructure: A Survey of

Microfoundations, Empirical Results,
and Policy Implications

Bruno Biais, Larry Glosten and

Chester Spatt
MARKET DESIGN

Market Microstructure: A Survey of

Microfoundations, Empirical Results,
and Policy Implications

Bruno Biais, Larry Glosten and

Chester Spatt
M A R K E T D E S I G N : PA R T I C I PA N T S

Market Microstructure: A Survey of

Microfoundations, Empirical Results,
and Policy Implications

Bruno Biais, Larry Glosten and

Chester Spatt
MARKET DESIGN:
T R A N S PA R E N C Y

Market Microstructure: A Survey of

Microfoundations, Empirical Results,
and Policy Implications

Bruno Biais, Larry Glosten and

Chester Spatt
MARKET DESIGN: PRICE CHANGE

Market Microstructure: A Survey of

Microfoundations, Empirical Results,
and Policy Implications

Bruno Biais, Larry Glosten and

Chester Spatt
TEXT BOOKS