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Centralised Order Books versus Hybrid Order Books:

Centralised Order Books versus Hybrid Order Books:. A Paired Comparison of Trading Costs on NSC (Euronext) and SETS (London Stock Exchange). Jean-François Gajewski Université de Paris XII Val de Marne, IRG Carole Gresse Université Paris Dauphine, CEREG. Topic of the paper.

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Centralised Order Books versus Hybrid Order Books:

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  1. Centralised Order Books versus Hybrid Order Books: A Paired Comparison of Trading Costson NSC (Euronext)and SETS (London Stock Exchange) Jean-François Gajewski Université de Paris XII Val de Marne, IRG Carole Gresse Université Paris Dauphine, CEREG

  2. Topic of the paper • Differences in trading mechanisms may imply differences in execution costs and spread components Harris(1997), Domowitz et al. (2001), Jain (2001) … • Many papers  order-driven markets vs. quote-driven markets Madhavan(1992), Pagano and Roëll (1992,1996), De Jong, Nijman and Roëll (1996),Huang and Stoll (1996) … • But few compare different types of order books Venkataraman (2001), Kasch-Haroutounian and Theissen (2003) • Two order-driven market designs • SETS (London Stock Exchange)Large caps (FTSE-100…), order book + multiple dealers • NSC (Euronext)almost pure centralised order-driven market • Common features / Organisational differences

  3. Organisational differences • Matching of all orders in the NSC electronic order book on Euronext • Bilateral negotiations with dealers outside the order book at the LSE • Processing of retail orders by Retail Service Providers at the LSE

  4. Testable hypothesesSuperiority of mixed structures(Jain (2001), Gresse (2002), Swan and Westerholm (2004))Fragmentation effects(Mendelson (19987), Chowdry and Nanda (1991), Easley, Kiefer & O’Hara (1996)) Volatility • H1. Prices are less volatile in the HOM (SETS) than in the COM (NSC). Spreads and trade size • H2. The internalisation of a substantial part of the order flow by dealers in the HOM fragments the market and enlarges quoted and effective spreads. • H3. Additional depth provided by dealers out the OB in the HOM • increases trade size (H3a) • lower trading costs on large transactions (H3b) Spread components • H4. Order-processing costs are greater in the HOM than in the COM. • H5. Inventory costs are greater in the HOM than in the COM. • H6. Higher pre-trade transparency in the COM  higher adverse selection costs • H7. ASC inside the order book of a HOM are greater than those incurred in a COM.

  5. Data and methodology • Data selection • Trading data and quotes during the first six months of 2001 • 211 securities continuously traded on Euronext Paris • 157 securities listed on SETS at the LSE • Sample matching • The Dow Jones economic sector • The free float capitalisation on January 2001 • The total trading volume (€) during the first semester of 2001 • 55 pairs of stocks

  6. Measurement of volatility,trading costs and spread components • Short-term volatility • Quoted spreads • Effective spreads • Effective marginal costs (empirical estimation of the Kyle’s l coefficient) • Spread components : Huang and Stoll’s methodology

  7. Analysis of execution costs on SETS and NSC

  8. Share in trading volume by transaction class 22.26% 21.73% 16..7% 16.34% 15.97% 15.69% 14.52% 14.71% 11.62% 10.99% 10.15% 7.27% 5.03% 5.37% 3.39% 3.39% 1.28% 0.76%

  9. Effective spreads by transaction class 0.9591% 0.7571% 0.7046% 0.6686% 0.6069% 0.5736% 0.5025% 0.5025% 0.457% 0.4704% 0.4622% 0.4386% 0.4199% 0.4103% 0.4147% 0.4038% 0.4038% 0.3435% 0.2673% 0.2793% 0.2564% 0.2469% 0.2476% 0.254% 0.2537% 0.2348% 0.2129%

  10. Components of the bid-ask spread on NSC and SETS (1) Huang & Stoll’s 2-way decomposition (GMM estimation) l= ASC + IHC in % of the spread 1-l= order processing costs in % of the spread

  11. Components of the bid-ask spread on SETS and NSC (2) Huang & Stoll’s 3-way decomposition (GMM estimation) a= adverse selection component b= inventory holding cost component Same conclusions with non-parametric tests on a 7-pair matched sample

  12. Economic and institutional factors explaining the difference in spreads: Panel regressions D Float cap. is not significant D # trades, DP: ns

  13. Concluding remarks Volatility • Short-term volatility of SETS stocks significantly exceeds the one of NSC stocks (Rejection of H1). Spreads and trade size • The hybrid order-driven market is globally more expensive(H2, rejection of H3b) but trades are larger in this market (H3a). Spread components • The order processing cost component = a much bigger part of the spread on the hybrid market than on the centralised order book (H4). • Weight of the inventory holding component is not lower on NSC than on SETS (rejection of H5)Higher on SETS when considering order book trades only. • ASC on SETS < ASC on NSC (week evidence, H6)but ASC is maximum on SETS when considering order book trades only (H7). Factors • tick size & share of volume executed by dealers in the SETS market

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