Market Microstructure in Emerging and Developed Markets

CHAPTER 2

Microstructure of Equity Markets

NAZLI SILA ALAN

PhD Candidate, Zicklin School of Business, Baruch College, City University of New York

RECEP BILDIK

PhD Director of Business Development and Marketing Department, Istanbul Stock Exchange

ROBERT A. SCHWARTZ

Marvin M. Speiser Professor of Finance and University Distinguished Professor, Zicklin School of Business, Baruch College, City University of New York

INTRODUCTION

Equity market microstructure, a relatively new field in financial economics, deals with the processes by which orders to buy or to sell shares are submitted to a marketplace and turned into trades and transaction prices. These processes are not simple because they involve human intermediaries, electronic technology, and a detailed rule book. The trading decisions of investors who turn to the markets to implement their portfolio decisions are not simple either. However, although the assumption is not always explicitly stated, the marketplace in standard financial and economic analyses typically assumes a perfectly liquid, frictionless environment, and the complexities of real-world markets are typically not considered.

The perfectly liquid, frictionless environment assumption simplifies both model building and classroom discussions. Consider, for instance, the capital asset pricing model (CAPM), a cornerstone of modern portfolio theory. The main CAPM assumptions are: unlimited borrowing and lending occur at the risk-free rate, shareholdings and share prices ...