slides for opening a financial market (introduction)
TRANSCRIPT
![Page 1: Slides for Opening a Financial Market (Introduction)](https://reader034.vdocuments.site/reader034/viewer/2022052601/558a8d0fd8b42a9d7a8b45a3/html5/thumbnails/1.jpg)
1
How to Open a Financial Market when Institutional Traders are
Present
Michael S. Pagano
Villanova University
![Page 2: Slides for Opening a Financial Market (Introduction)](https://reader034.vdocuments.site/reader034/viewer/2022052601/558a8d0fd8b42a9d7a8b45a3/html5/thumbnails/2.jpg)
2
Is trading this simple? …
![Page 3: Slides for Opening a Financial Market (Introduction)](https://reader034.vdocuments.site/reader034/viewer/2022052601/558a8d0fd8b42a9d7a8b45a3/html5/thumbnails/3.jpg)
3
or slightly more difficult ??
![Page 4: Slides for Opening a Financial Market (Introduction)](https://reader034.vdocuments.site/reader034/viewer/2022052601/558a8d0fd8b42a9d7a8b45a3/html5/thumbnails/4.jpg)
4
What Motivates Trading?
1. New information (news)
2. Liquidity needs
3. Divergent expectations (people agree to disagree)
4. Technical (noise) trading
![Page 5: Slides for Opening a Financial Market (Introduction)](https://reader034.vdocuments.site/reader034/viewer/2022052601/558a8d0fd8b42a9d7a8b45a3/html5/thumbnails/5.jpg)
5
Fundamental Financing Channels
Firm Investor
Firm InvestorIB / CB
Buyer Seller
Agent
Exchange
or Market Maker
Agent
![Page 6: Slides for Opening a Financial Market (Introduction)](https://reader034.vdocuments.site/reader034/viewer/2022052601/558a8d0fd8b42a9d7a8b45a3/html5/thumbnails/6.jpg)
6
Purposes of Financial Markets
• Set Prices for financial assets
• Exchange Information
• Raise Capital for Issuers (Primary Mkt)
• Liquidity for Investors (Secondary Mkt)
• Vehicle for Managing Risk
![Page 7: Slides for Opening a Financial Market (Introduction)](https://reader034.vdocuments.site/reader034/viewer/2022052601/558a8d0fd8b42a9d7a8b45a3/html5/thumbnails/7.jpg)
7
Major Trading Issues
• Liquidity
• Price & Quantity Discovery
• Volatility
• Transaction Costs
• Trading Profits for Market Makers
• Net Investment Returns
![Page 8: Slides for Opening a Financial Market (Introduction)](https://reader034.vdocuments.site/reader034/viewer/2022052601/558a8d0fd8b42a9d7a8b45a3/html5/thumbnails/8.jpg)
8
Order Revelation in a Financial Market
“Bookbuilding” is the process of:– revealing orders and/or trades, – forming an active market with numerous
traders, – discovering the asset’s price (price
discovery), and– deepening the order “book” and/or building
trading volume (quantity discovery).
![Page 9: Slides for Opening a Financial Market (Introduction)](https://reader034.vdocuments.site/reader034/viewer/2022052601/558a8d0fd8b42a9d7a8b45a3/html5/thumbnails/9.jpg)
9
Challenges of Order Revelation
• It is not a simple process.• Existence of an order is information that
can be used against the trader submitting the order (i.e., it is like a “free” option given to other traders).
• Adverse price changes can occur due to:– Market Impact of large orders,
– Front-running, and
– Mis-pricing of early orders.
![Page 10: Slides for Opening a Financial Market (Introduction)](https://reader034.vdocuments.site/reader034/viewer/2022052601/558a8d0fd8b42a9d7a8b45a3/html5/thumbnails/10.jpg)
10
Challenges for Large Traders
• Large, institutional traders know that their actions can impact market prices.
• Large traders are more likely to suffer “ex post” regret about their trades.
• Therefore, many large traders do not fully reveal their order sizes, thus creating strong, latent demand to buy and/or sell.
![Page 11: Slides for Opening a Financial Market (Introduction)](https://reader034.vdocuments.site/reader034/viewer/2022052601/558a8d0fd8b42a9d7a8b45a3/html5/thumbnails/11.jpg)
11
A Two-Sided Market with Unequal Orders
![Page 12: Slides for Opening a Financial Market (Introduction)](https://reader034.vdocuments.site/reader034/viewer/2022052601/558a8d0fd8b42a9d7a8b45a3/html5/thumbnails/12.jpg)
12
“Most Inefficient” Outcome via Order Shading
![Page 13: Slides for Opening a Financial Market (Introduction)](https://reader034.vdocuments.site/reader034/viewer/2022052601/558a8d0fd8b42a9d7a8b45a3/html5/thumbnails/13.jpg)
13
“Most Efficient” Outcome via Open Book
![Page 14: Slides for Opening a Financial Market (Introduction)](https://reader034.vdocuments.site/reader034/viewer/2022052601/558a8d0fd8b42a9d7a8b45a3/html5/thumbnails/14.jpg)
14
Building to an Efficient Outcome with Multiple Orders
![Page 15: Slides for Opening a Financial Market (Introduction)](https://reader034.vdocuments.site/reader034/viewer/2022052601/558a8d0fd8b42a9d7a8b45a3/html5/thumbnails/15.jpg)
15
The Iceberg of Transaction Costs
Source: Plexus Group, 2003
Commission 5 ¢ (17 bp)
ImpactImpact10 ¢ (34 bp)10 ¢ (34 bp)
Delay23 ¢ (77 bp)
Missed Trades9 ¢ (29 bp)
![Page 16: Slides for Opening a Financial Market (Introduction)](https://reader034.vdocuments.site/reader034/viewer/2022052601/558a8d0fd8b42a9d7a8b45a3/html5/thumbnails/16.jpg)
Trading Mechanism
Informed
Is p*>offeror p*<bid?
Orders Come from 3 Types of Traders
LiquidityOrder Flow
Quotes,Prices,Volume
Technical Trading
Is there a trend/pattern?
P*
Do the informedTraders agree with
each other? maybe not!
![Page 17: Slides for Opening a Financial Market (Introduction)](https://reader034.vdocuments.site/reader034/viewer/2022052601/558a8d0fd8b42a9d7a8b45a3/html5/thumbnails/17.jpg)
![Page 18: Slides for Opening a Financial Market (Introduction)](https://reader034.vdocuments.site/reader034/viewer/2022052601/558a8d0fd8b42a9d7a8b45a3/html5/thumbnails/18.jpg)
18
$21.00
$22.00
$23.00
$24.00
$25.00
$26.00
$27.00
$28.00
Ask
Bid
P*
Day 1 Day 2
De-Briefing: P*, Best Bid and Offer Quotes, and Price Impact
![Page 19: Slides for Opening a Financial Market (Introduction)](https://reader034.vdocuments.site/reader034/viewer/2022052601/558a8d0fd8b42a9d7a8b45a3/html5/thumbnails/19.jpg)
19
Key Questions
• How did you do in terms of achieving your goal? (e.g., did you get the shares at a “good” price?)
• What types of orders / trading strategies worked best? Which worked worst?
• What do you think caused the bid-ask prices to diverge from the equilibrium P* values?
• Did you shade your orders or did you feel comfortable submitting large orders?