Financial Markets and Trading: An Introduction to Market Microstructure and Trading Strategies

CHAPTER 6

Empirical MarketMicrostructure

Empirical analysis of market microstructure focuses on specifics of order flows, the bid/ask spread, and structure of the limit-order book. Significant amount of empirical market data has been accumulated in the literature (see Hasbrouck 2007 and de Jong & Rindi 2009, for a review). However, since financial markets continue to evolve with ever changing macroeconomic conditions, new technology, and regulation, much of the information relevant to empirical market microstructure may need regular updating.

Several theoretical models have been used in empirical market microstructure research. In the next section, I describe the classical Roll's model (1984) of the bid/ask spread. Then, I turn to the Glosten-Harris model (1998), which quantifies the contribution of the adverse selection into the bid/ask spread. In contrast to these and other models discussed in Chapters 3 through 5, some models used for analysis of empirical microstructure are not derived using some assumptions on the trader behavior, market structure, and price dynamics; rather, they are based on the regression analysis of the variables of interest. These structural models pioneered by Hasbrouck (1991) have become a popular tool in empirical analysis. I describe one such model in this chapter. Finally, I provide an overview of some recent empirical findings in the equity and FX markets.

ROLL'S MODEL

The Roll's model (1984) relates the bid/ask spread to transaction prices. Hence, ...