Upending Stock Market Structure Using MPC

CHARANJIT S. JUTLA

IBM RESEARCH

Talk Outline•What exactly is the purpose of the stock market?

•Is there a problem with the stock market?

•Demand and Supply (Eco-101)

•Modeling (Private) Information in Equilibrium Pricing

•Price Discovery Mechanisms

•Novel (or antiquated) Structure of Stock Market

•Illustrative Analysis

Stock Market Purpose Price Discovery

◦ Important for investment decisions◦ Effectively centralizes distributed information

Liquidity – it is a market! NYSE vs NASDAQ (Double Auctions)

Is there a problem?◦ What’s with all the day traders and HFT? Liquidity?◦ Trusting the Specialist to hide your bids?◦ Let’s Model

Walrasian Equilibrium (1877)

Walrasian Equilibrium

Grossman-Stiglitz Critique (1980)

Impossibility of Informationally efficient markets◦ Efficient Markets Hypothesis – Prices reflect all the information◦ Even “Informed” Traders “Private” Information?◦ Then informed traders have no incentive.◦ So, in “equilibrium” no one is doing any research!◦ But, that is not an equilibrium!◦ CONCLUSION: Prices do not reflect all the information.

Easley-O’Hara Model (2004)

price

Cumulative Demand and Supply

BUYSELL

Market price buyMarket price sell

CLEARING PRICEDOUBLE AUCTION

(CPDA)

price

Cumulative Demand and Supply

price

Cumulative Demand and Supply

s

Upshot If there is no private signal, or “signal” is public knowledge:

◦ converges to Walrasian equilibrium.◦ incentivizes “uninformed”.

Private Information is clearly not revealed till auction is over.◦ Informed are further incentivized.◦ Uninformed continue to get a return (so liquidity providers remain).◦ If everyone does research, faster equilibrium pricing!

Open Questions?◦ Mostly Finance Questions. ◦ But, Additional Leakage - Performance Tradeoffs.◦ Treating Buyers and Sellers symmetrically in analysis.◦ Volume reveals signal after auction is over in simple model.◦ Periodic CPDA.

THANKS!