Bid-ask spread and liquidity determinants across various market structures on the italian bourse.
[Tesi di dottorato]
This dissertation consists of three essays that examine liquidity across several market structures. The research provides empirical evidence on increasingly significant issues given the rapid increase in structural changes across international equity markets. Each essay addresses some inconclusive research in order to aid researchers, investors and regulators in the course of understanding and managing the liquidity provision of various market structures.
The first essay analyzes liquidity surrounding earnings announcements on the Italian Bourse. Studies of market reaction surrounding earnings announcements use bid-ask spreads to proxy for information asymmetry. It is proposed that the use of spreads posted by NYSE specialists or Nasdaq dealers is problematic in previous tests since dealer spreads reflect the market power of dealers. This essay addresses these problems by examining bid-ask spreads surrounding earnings announcements for stocks that trade in a purely order-driven environment. The problems encountered in previous studies are mitigated. The results indicate that bid-ask spreads increase significantly around earnings announcements, reflecting an increase in information asymmetry in contrast to previous studies using daily data from US markets.
The second essay analyzes liquidity across auction and specialist market structures. Several studies find that bid-ask spreads for stocks listed on the NYSE are lower than for stocks listed on Nasdaq. However, the hybrid nature of trading on the NYSE, which comprises a specialist and a limit order book, clouds the comparison. In 2001, a structural change was implemented on the Italian Bourse, which provides a cleaner experiment for examining this issue. Many stocks that traded in an auction market switched to a specialist market, where the specialist controls the order book. Results indicate that spreads tighten when stocks move to the specialist market. This reduction in spreads is robust to market capitalization, industry affiliation and different observation periods around the structural change. The specialist’s ability to offer price improvement further lowers the cost of executing trades. Specialist market structures are more advantageous to market participants.
The final essay analyzes intraday patterns in bid-ask spreads across auction and specialist market structures. Several studies have analyzed liquidity across a trading day, and have documented that bid-ask spreads exhibit a U-shaped pattern, with spreads wider at the start and end of the trading day, whilst spreads are tighter in the middle of the day. This pattern has been attributed to inventory holding costs, the specialist’s market power and adverse selection risk. The structural change on the Italian Bourse provides a natural experiment where intraday patterns in spreads across different market structures can be compared. Results indicate that volume, volatility and bid-ask spreads exhibit the U-shaped intraday pattern both before and after the structural change. While time-weighted spreads are consistently higher throughout the trading day under the specialist structure, the specialists ability to offer price improvement within the best quotes results in the ‘real’ cost of trading being lower under a specialist system. These results are robust to the size of the firm, the event window around the structural change, as well as overall market-wide changes.
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