FIE447 Trading, Liquidity, and Pricing in Securities Markets

• Topics

  This course deals with how financial securities are traded, and how the structure of markets affects price formation, market liquidity, and asset allocation. In most finance courses, the mechanism behind the determination of prices is treated as a black box. In this course the box will be opened and we will study how actual market trading mechanisms and market participants affect pricing, liquidity, and asset allocation.

  We will study how trading frictions generate deviations of assets prices from their fundamental value and how these deviations are exploited through arbitrage; how prices are formed when markets are designed as limit order markets, dealer markets, dark pools and call auctions; how market liquidity is defined and how it is affected by market design, market participants, and how market liquidity in turn affects the decisions of the various market participants. Topics are:

  • Market efficiency and arbitrage
  • Trading mechanics and market structure
  • Defining, measuring, and estimating market liquidity
  • Trading and price discovery
  • Key players of the trading industry
  • Market design and regulation
  • Market transparency
  • The effect of liquidity, and price discovery on corporate finance policies

• Learning outcome

  After completing this course, students shall know

  • the difference between various trading platforms such as limit order markets, dark pools, over-the-counter markets, and call auctions.
  • how trading and arbitrage affect price discovery.
  • how real world markets operate in the formation of market prices and price discovery.
  • how market liquidity and market prices are related to trading frictions such as asymmetric information, inventory holding costs, and direct trading costs.
  • how asset allocation is affected by trading costs and illiquidity, and how to account for illiquidity and transactions costs in portfolio management.
  • the difference between market orders and limit orders and how traders choose between these.
  • costs and benefits of market fragmentation and how these relates to liquidity externalities.
  • the difference between market efficiency and real efficiency and how market prices affect corporate investment decisions.
  • why illiquidity and liquidity risk affect security prices and returns.
  • how funding liquidity impacts market liquidity.

  In terms of skills and general competence, students shall be able to

  • assess the quality of financial markets
  • derive and explain key theoretical models of market microstructure such as the Glosten&Milgrom and Kyle models in terms of real world financial markets
  • assess aspects of financial regulation (such as the MiFID II directive) in terms of market microstructure and the efficiency (information and allocative) of financial markets
  • explain the role of market microstructure on the financial policies of firms
  • use market microstructure theory to explain patterns observed in financial market prices as revealed by empirical evidence

• Teaching

  The topics will be taught through lectures. Student participation is strongly encouraged. Lectures will not be streamed. Some topics may be available in pre-recorded lectures.

• Recommended prerequisites

  Students are expected to have basic knowledge in finance as covered in courses such as FIE 400 Investments and FIE 402 Corporate Finance.

• Compulsory Activity

  Approval on two out of two assignments. The assignments may be done in groups of up to five members.

• Assessment

  Written individual home exam (4 hours): 100%

• Grading Scale

  A - F

• Literature

  Market Liquidity. Theory, Evidence, and Policy by Thierry Foucault, Marco Pagano, and Ailsa Röell, Oxford University Press

  Additional readings may be assigned

• Permitted Support Material

  TBA