This course studies models of financial markets (market microstructure), and in particular, how asset prices are established in actual markets such as the stock exchange. It differs from asset pricing theory in which prices are assumed to be set such that supply and demand are equated via some costless auction-type frictionless mechanism that remains an undisclosed ‘black box’. Actual markets require actual rules and these rules affect the way in which prices are established, the way in which information possessed by traders is incorporated into asset prices, why some markets and stocks are liquid and why some markets are more fragile and costly than others. A few years ago, brokers were collectively able to set high minimum fees, exceedingly high minimum spreads (transaction costs reflecting the minimum tick size), monopoly provision of limit-order placement by the ‘specialist’, prohibition on the entry of alternative exchange mechanisms and numerous other anti-competitive practices designed to protect stockbroker incomes.

Major markets such as the New York Stock Exchange (NYSE) remained unable to open for hours during crisis periods such as occurred in 1987. In part due to the huge growth in both market microstructure theory and empirical work in recent years, stock markets have become far more competitive in recent years but many remain opaque and it is far from clear that pricing efficiency has improved. This course provides the necessary theoretical insights to comprehend the nature of these radical changes and to understand the direction that both competition and design rule changes are taking global exchange activities for stocks and other financial instruments.

All wealth creation requires an understanding of how asset prices are actually set, how investors can draw on their assets (wealth) when needed, i.e., their liquidity, and at what cost. Should investors delegate choice of their portfolios for their retirement to others or should they become active traders themselves? If so, how and where should they trade? This market microstructure course helps to address many of these fundamental issues, as well as equip students to read, understand and apply the rapidly developing market microstructure literature.