This course surveys recent contributions in market microstructure theory.
Market microstructure is the study of the process and outcomes of exchanging
assets under explicit trading rules. With explicitly specified asset trading
mechanisms, optimal trading strategies for different classes of traders are
identified, and the properties of the resulting equilibrium price and volume
are examined.
It will start with a review of the benchmark rational expectations equilibrium
(REE) models, where traders are price-taking but endowed with
differential information. Then we will review the theory of speculation and
bubbles, and clarify and role of the no-trade theorem.
Then we will review the information-based dealership models.1 We will
consider both quote-driven and order-driven mechanisms. We shall discuss
static and discrete-time dynamic models.
Then various market features will be considered. This includes a comparison
of fragmented and centralized markets, markets with and without a limit
order book, and markets with competitive dealers and with a monopolistic
specialist.
It will then consider the theories of trading volume and then the possible
economic causes of market crash. Then we will review the pros and cons
of insider trading from the perspectives of social welfare and of investment efficiency, and discuss how the presence of a derivative asset market affects
insider trading.
Finally, if time allows, we shall review some continuous-time models of
insider trading.
Problem sets solving and the performances in the midterm exam and
an oral presentation will jointly determine a student’s grade. A tentative
schedule now follows.
Week 1 Rational Expectations Equilibrium (REE) Models
Week 2 REE Models (continued)
Week 3 Speculation, Bubbles, and No Trade Theorem
Week 4 Classical Dealership Models
Week 5 Order-driven Mechanisms I
Week 6 Order-driven Mechanisms II
Week 7 Quote-driven Mechanisms
Week 8 Comparing Different Markets
Week 9 Comparing Different Markets (continued)
Week 10 Th