Nuances of Trading

The devil (and the dividends) is in the details
by Dr. Robert Van Ness and Dr. Bonnie Van Ness

Certain to have a dramatic impact on financial markets, the New York Stock Exchange (NYSE) announced its merger with Archipelago Holdings to become more of what investors want: a for-profit, publicly held company with electronic trading capabilities.

In the aftermath of the merger, will investors realize more benefits across the board? Will the move make the market more efficient? Will trading costs be reduced? Will trading become easier or more accessible? Will the merger lead to better trading or did it reduce liquidity and hurt trading overall?

These questions and other market changes are being examined by UM finance professors and researchers Dr. Bonnie Van Ness and Dr. Robert Van Ness. Both study market micro-structure, which involves how financial market structure affects trading and quoting on the various exchanges. Their work continues to draw the attention of the Securities Exchange Commission (SEC), U.S. Department of Justice, the financial market and individual professional traders.

“The increase in online trading and the emergence of large electronic markets, such as Archipelago, is altering the trading landscape,” says Robert Van Ness. “Examining the impact of these changes in the investment environment aids in the understanding of how the United States can have the most efficient trading system.”

The volatile financial market of recent years keeps investors on the edge of their seats, frequently checking the status of their stocks. Those same changes create additional research opportunities for the UM professors, who have had their work posted on the NYSE Web site.

“Our uncertain world leads to more volatility in the market,” says Bonnie Van Ness. “Any news announcement can cause a reaction in the market.

“Much has happened in the financial markets over the last decade,” she says. “Some of the changes have been regulatory in nature, and many of the changes have been initiated by markets due to investor demand. We look at these changes—such as the SEC instituting a new regulation—and try to determine the impact. How did the change affect market microstructure? What happened to the trading costs of the individual investor? How did the move affect the costs the dealers incur?”

The UM researchers currently are looking into locked-and-crossed markets, which are causing friction within the trading process.

“In a properly functioning stock market, the ask (or buy) price should be higher than the bid (or sell) price, but due to market changes, that’s not always occurring,” Robert Van Ness says. “A market becomes locked when the ask price and bid price are equivalent, and trading actually has to stop on some venues until the prices reverse. Periodically, the market crosses when the bid price becomes higher than the ask price—something that should not happen, according to the SEC. On the NYSE, it occurs periodically, but with the most active stocks on the NASDAQ, crossing occurs much more frequently. In total, locked-and-crossed markets account for almost 10 percent of the trading time for the average NASDAQ stock. We’re trying to get at the root cause of why this occurs so that the markets can try to enforce rules or change rules to enable trading to flow freely.”

Bonnie Van Ness concurs, saying, “Locked-and-crossed markets may impact capital market efficiency. People buy stocks versus real estate due to liquidity reasons: They can buy and sell stocks at a moment’s notice. Locked-and-crossed markets slow this down. We find that, on average, the market in a particular stock is crossed only a few seconds at a time, but the price change during this time can hurt the individual investor.”BF