Course Scope

The main goal of the course is to introduce the students to the basic concepts and theories that have been developed in recent years for markets’ microstructure. More specifically, the subjects the course will study:

– The distinction of markets into primary and secondary and into markets of organized or over-the-counter mechanisms
– The theory of formation of prices and trading volumes, the concept of equilibrium and efficiency in a securities market
– The price spread and the concept of liquidity of a market and the “central” role of the central market maker
– The strategic behavior of investors and its effect on prices
– The categories of the orders and their properties
– The information asymmetry and the way it is modelled
– How the liquidity of a market is defined, measured and affected

Course Outline

1) The distinction of markets
• In primary and secondary markets.
• In organized markets (organized exchange).
• In money and capital markets (money market and capital market).
• The structure of markets and trading protocols.

2) Setting prices and trading volumes
• The concept of equilibrium in a market (market equilibrium).
• The concept of rational expectations.
• The concept of efficiency in a market (efficiency).
• Setting prices through an auction.

3) The price spread and the factors that affect it
• The concept of market liquidity.
• The “central” role of the central negotiator (market maker).
• Inventory cost and risk
• The importance of asymmetric information.

4) Strategic behavior of participants
• The distinction of investors.
• The competition between central negotiators.
• The application of game theory.
• Deviation from market efficiency due to strategic behavior.

5) The categories of orders
• Buy and sell orders
• Order composition and investment objectives.

6) Information asymmetry
• The importance and source.
• How it relates to price margin.
• Basic mathematical models.
• Investment strategies derived from asymmetry.

7) Liquidity
• Definitions and meanings
• Liquidity measures
• Influencing factors

Suggested Reading

• de Jong, F. and Rindi, B. (2009). The Microstructure of Financial Markets, Cambridge University Press.
• Foucault, T., Pagano, M., & Roell, A. (2013). Market liquidity: Theory, evidence, and policy. Oxford University Press.
• Harris, L. (2003). Trading and exchanges: Market microstructure for practitioners. Oxford University Press.
• Hasbrouck, J. (2007). Empirical Market Microstructure: The Institutions, Economics, and Econometrics of Securities Trading. Oxford University Press.