Home | Business News | Browse by Publication | I | International Advances in Economic Research

Market microstructure and security pricing in the Warsaw market.

Article Excerpt
Abstract

The speed with which information is impounded in security prices is evaluated with respect to several market microstructure variables in the context of a dynamic, rapidly-changing market, the Warsaw Stock Exchange. The dynamic nature of this market allows for predictions concerning pricing efficiency in more mature markets as they merge or expand their number of offerings. The results indicate that the performance of the Warsaw Exchange compares favorably with that of the average security traded on the NASDAQ. To the extent that recent mergers of several exchanges have had the effect of engaging more market participants and enhancing trading opportunities through expanded hours, trading efficiency has been positively affected. There is also weaker support for the view that consolidating securities on fewer exchanges will improve informational efficiency as well. (JEL G10, D40, L10)

Introduction

An important economic function of markets is to convey information about the macro-economy and about firm-specific events. When prices reflect this information efficiently, the allocation of real resources is enhanced. Thus, the impact of financial market microstructure on security pricing has received considerable attention in recent years. (1) Most of these studies are based on the University of Chicago's CRSP data set which has the advantage of offering a long-term consistent series on a large number of securities. One drawback of these data, however, is that they reflect mature markets in which some variables of interest, such as the number of securities or shareholders, do not vary much from year-to-year. A long-term time series analysis must correct for macroeconomic changes which may not be well specified.

In common with other recent research, this article examines the impact of market microstructure variables on the efficiency of security pricing. The main contribution here, is to do so within the context of an emerging, and therefore, rapidly-changing market, the Warsaw Stock Exchange. The dynamic nature of this market is used to examine structural factors affecting the efficiency of security pricing while confining the analysis to a short-term time span and so to extrapolate from macroeconomic factors. The goal is to provide empirically "cleaner" tests than previously possible. A secondary purpose of this paper is to compare the efficiency results of a new market with those of more established exchanges in order to see how pricing efficiency relates to that in more established counterparts.

Several themes suggest themselves in this context. For example, the number of shareholders in mature U.S., Japanese, and European markets has been decreasing in recent years as institutions have increased their holdings. (2) This might reduce the efficiency with which these markets operate, if the competition for information is thereby reduced. On the other hand, if increased institutional shareholdings mean that "noise" trading by small investors is reduced, then markets may operate more efficiently. About the same time that the Amsterdam, Brussels, and Paris Stock Exchanges were joining to become Euronext, the planned merger between the London and Frankfurt exchanges was falling through. Across the Atlantic, the AMEX was merged into the NASD system to create a combination of exchanges with a larger trading volume than the New York Stock Exchange. This suggests that the exchanges believe that market size matters. Similarly, the impact of longer trading hours has also been the subject of some discussion and t here is speculation that one or more of the New York markets is considering an affiliation with Asian exchanges as a way to take advantage of this. Largely untested, these effects have been assumed rather than evaluated. This is partly because the impact of such changes is hard to measure in mature markets because the short-term variation in the underlying variables is low.

This paper examines the impact of microstructure variables--number of market participants, number of securities listed, frequency of trading, and firm size--on the transmission of economic information and pricing efficiency. The first section gives a brief overview of the Warsaw Stock Exchange and the market-making process. Section two develops a transactions cost model based on the Limited Dependent Variable model of Lesmond, Trzcinka, and Ogden [Lesmond et al., 1999] and applies this model to the informational model of Mech [19931. Section three presents empirical tests of both models and describes the data sources and discusses measurement issues. This section also presents the hypothesis and develops operationalized models. The final section summarizes the findings and discusses the implications for both mature and developing markets.

The Warsaw Exchange

Founded in 1817, but closed for over fifty years, the re-organized Warsaw Stock Exchange held its first trading session on April 16, 1991 only four days after its incorporation and less than a month after the enabling legislation was passed by the Polish parliament. (3) The Exchange listed the shares of five newly-privatized firms and turnover the first session amounted to about $2000. This paper focuses on the time period from 1991 through the end of 1995. This was a time of rapid economic change in the Polish economy and of great growth of the exchange. Modeling information in such an environment is particularly interesting because economic uncertainty should provide a conservative view of information transmission. If there is going to be "noise" trading, this would be a perfect time to see it. At the same time, the rapid growth in the market gives us substantial variability in the microstructure variables of interest.

Trading is organized on the basis of a single-price (Einheitspreis) auction model. Since 1994, trading sessions have been held five days per week. Shareholders must have an account with a member of the exchange who can submit orders on their behalf until 10:45am on the session day. Market or limit orders may be placed and "all or nothing" instructions may be given. Each listed security has an exchange specialist who establishes the single session price and who may act to stabilize the market in the event of unmatched orders. The session price is set to maximize turnover with a maximum price deviation of ten percent from that of the previous session....

View this article FREE - Now for a Limited Time, try Goliath Business News
Free for 3 Days!