Course description

Market Microstructure

Introduction

Please note that this course will be revised before it is offered again.

This course is intended for PhD students in finance and related fields. The course is an introduction to market microstructure. Market microstructure has grown rapidly and has become and important subfield of Finance. Research in this field focuses on relationships between price volatility, liquidity, market design and price discovery. Market microstructure models provide a framework for analyzing price determination in financial markets at the micro level. For instance, researchers in this field have analyzed the impact of asymmetric information on liquidity and volatility. There is also a broad literature that analyzes the impact of market design with respect to e.g. transparency, anonymity and auction versus dealer market. Market microstructure has important policy implications for the organization and regulation of security markets.

In this market microstructure course there will be a special attention to the application of market microstructure tools to other fields in Finance. Examples here are asset pricing, behavioral and corporate finance. Microstructure tools have also been very useful to improve our understanding exchange rates and bond pricing. For instance, there is ongoing research combining the macro approach of foreign exchange with market microstructure.

Knowledge of a software package such as SAS, RATS or Eviews etc., or programming skills are required.

Course content

1. Asymmetric Information and Inventory Management

  • Order Flow and adverse selection
  • Sequential trade models of asymmetric information
  • Order Flow and the Probability of Informed Trading (PIN)
  • Strategic Trade Models

2. Limit Order Markets – Determinants of Depth and Dynamic Order Submission Strategies

  • Overview of limit order markets and market design
  • Determinants of Depth and Dynamic Order Submission Strategies
  • Empirical analysis of limit order markets

3. Market Microstructure and other fields of Finance

  • Asset pricing
  • Corporate finance
  • Behavioral finance

4. Market Microstructure and Foreign exchange
The determination puzzle – traditional approaches for FX rate determination
Order Flow and Macro News
Customer Order Flow

A complete list of articles and book chapters will be distributed before the first meeting.

Learning outcome knowledge

  • To understand core theory of Market Microstructure
  • To understand special features of Limit Order Markets and in particular determinants with respect to depth and dynamic order submission strategies
  • To get insight into how Market Microstructure relates to other fields of finance (Asset Pricing, Corporate Finance and Behavioral Finance)
  • To understand the Market Microstructure Approach to foreign exchange and why this approach can help understanding the failure of macro models
  • To understand interrelations between stock, bond and foreign exchange markets from a Market Microstructure perspective

Exam organisation

  • Class participation: 40%
  • Written assignment: 60%