An Index Methodology for Analyzing and Comparing the Development State and Trading Architecture of Stock Markets
Before participating in a stock market, investors compare it with other stock markets. For the comparison, three factors are often mentioned in the literature: stock returns, their associated risk, and the cost of trading. The present chapter concentrates on the influence of the development state and trading architecture on the trading costs in the LAEM.38 The design of indexes has proved to be an efficient way to make comparisons between stock markets (Demirgüc-Kunt and Levine (1996), Erb, Harvey, and Viskanta (1996)). By means of indexes, it is possible to answer three questions: (1) How heterogeneous are the implicit trading costs in the LAEM? (2) How different are the implicit trading costs of the LAEM from the developed markets? And of considerable importance: (3) Which factors are responsible for the differences? To answer these questions is the chief aim of this chapter. To do so, two main indexes are constructed here: the DS-Index and the TA-Index. Because they determine the implicit costs, the focus in what follows will be on the development state and the trading architecture.
KeywordsStock Market Stock Exchange Trading Cost Trading System Market Concentration
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- 45.It is also assumed that more mature economies rely more on equity markets (Boyd and Smith (1996)).Google Scholar
- 54.The analysis of the importance of market-makers in the trading process is not new. Demsetz (1968) showed that market-makers receive the bid-ask spread as the premium for their predictive immediacy services. The bid-ask spread is important because it is part of intraday price dynamics. Smith (1971) extended the analysis of the market-makers. He argued that the primary activity of the market-makers remains the supply of immediacy, but they are also active in the price-setting process in order to adjust their inventories. It implies that prices may depart from their expected values if the dealer position differs from their target, thereby giving rise to transitory price movements over the course of the day and possibly over longer periods. More recent studies have considered the impact of information on market prices. Informed traders expect to make profits from uninformed traders. Market-makers will on average lose with informed traders and win with uninformed ones, which suggests that an informational component might be contained in the spread (Glosten and Milgrom (1985)).Google Scholar
- 56.For a discussion of other factors that influence market equilibrium prices see, e.g., Madhavan (2000) and Pohletal. (1995).Google Scholar
- 57.After analyzing the interaction between market structure, order size, and liquidity, Freihube, Krahnen, and Theissen (2002) conclude that “all auctions are best suited to small orders.”Google Scholar
- 65.Harris (1996) finds that hidden orders must be used more frequently in volatile markets, but also that the fraction of hidden orders and the size of the hidden portion increase with the volatility.Google Scholar
- 74.However, shortening the settlement time generates some disadvantages. For example, the number of trades that fail to settle may increase (see Guadamillas and Keppler (2001)).Google Scholar