research@hec - Issue #9 - (Page III)

Inter-Stock Market Competition and Market Liquidity Key Ideas market entrants. •Empirical evidence shows that trade-throughs are quite frequent and are prejudicial to •There is a negative cross-sectional relationship between the frequency of trade-throughs and market entrant competitiveness in terms of liquidity supply. In the past decade, the upsurge of electronic trading venues (first in the United States and more recently in Europe) has radically changed financial transactions. While national stock exchanges had enjoyed virtual monopolies of their respective markets, increased competition raised numerous questions and generated revisions of market regulations. Hence the recent Regulation NMS1 in the United States and the MiFID2 in Europe. Transaction-related matters have been a major focus since 2006, but a crucial question has remained unanswered. What exactly are the benefits and costs of inter-stock market competition? Foucault and Menkveld’s study provides a preliminary response. M INSIGHT FROM THE EUROSETS LAUNCH In November 2007, the MiFID put an official end to national monopolies of European stock markets. The London Stock Exchange (LES) had anticipated this measure and therefore launched EuroSETS in 2004. This electronic trading venue was conceived to boost competition on the Dutch stock market and was almost identical to NSC, the Euronext electronic trading platform. EuroSETS consequently represented a fitting subject for empirical research on the impact of competition between stock trading structures (see insert “Research Method”), and its launch enabled Foucault and Menkveld to investigate whether “switching from a centralized limited order book to a more fragmented environment impairs or improves liquidity.” More specifically, the researchers undertook to answer the following questions: • Does the centralization of order flow improve liquidity? Does competition between stock markets lead to an increase in liquidities on the markets? • Should limited orders be protected from tradethroughs? Do traders have sufficient incentive to seek out the best prices? TRADE-THROUGHS AS MEANS TO EVALUATE MARKET LIQUIDITY On a fragmented market, orders are frequently executed at prices that are worse than the best quoted prices. Indeed, traders often pay more for stock shares than the best market rate would require, because they tend to prefer one specific stock exchange to others. This practice is referred to as a violation of price priority or tradethrough, and despite a lack of empirical proof, stockbrokers generally consider that tradethroughs discourage liquidity supply. Foucault and Menkveld have tested this intuitive belief using a model presenting two hypotheses: • The launch of EuroSETS should deepen the consolidated limit order book (the sum of books across markets). • There should be an inverse correlation between the liquidity of EuroSETS vs. NSC and the frequency of trade-throughs. Albert Menkveld Thierry Foucault BIOGRAPHIES Thierry Foucault is a finance professor at HEC Paris and a research fellow at the Center for Economic Policy. He has been an academic fellow at the EIF since 2003 and is a member of the GREGHEC (CNRS). Foucault has taught internationally at schools including Carnegie Mellon University (USA), the Nordic Finance Network, Oxford University (Saïd Business School), and Pompeu Fabra University (Spain). holds a PhD from Erasmus University in Rotterdam and is currently an associate professor of finance at VU University of Amsterdam. He has been a member of the scientific board of France’s Financial Market Authority (AMF) since 2004. In 2007, Menkveld received the Pierson medal, a biannual prize attributed to a young Dutch researcher in economics by the Royal Dutch Economic Association. June-July 2009 • research@hec III

Table of Contents for the Digital Edition of research@hec - Issue #9

Cover & Contents
Organization, Business, and Society
Inter-Stock Market Competition and Market Liquidity
Sales Force Compensation: TheWeight of Net
IFRS: The Revolution That NeverWas (at least not yet!)

research@hec - Issue #9