Korea Stock Exchange, Australian Stock Exchange, New York Stock Exchange, NASDAQ; Fragmentation & Market Quality

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This presentation consists of 2 sections …

This presentation consists of 2 sections

1. An overview of Korea Stock Exchange and Australian Stock Exchange, accompanied by a comparison of the two exchanges

2. A discussion of Bennett & Li "Market Structure, Fragmentation, and Market Quality" article which looks into market fragmentation on New York Stock Exchange and NASDAQ

This was done as part of a project for University of New South Wales

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  • WE ARE GROUP 13, we have analyzed the korea and australian stock exchange. This is Setefan, Tai, harry myself.
  • Lets start with the statisticWe found that The market cap on asx is bigger than KRX whereas krx is bigger in terms of trade value. Through out the rest of our presentation, we will give you the possible reasons that make such a difference here.
  • This is the history of KRX, their vision is to be a premier exchange, leading global capital market. And they integrated KSE, Korea futures, KOSDAQ in 2005. they are founded in 1956 and ranked 17 by market cap and 8 by trade value. Which is followed by usa,china, japan,london.http://www.marketswiki.com/mwiki/Korea_Exchangehttp://www.ksri.org/bbs/files/research02/SSRN_ID355361_code021218500.pdf
  • Two main exchange boards are KOSPI and KOSDAQ. KOSPI was introduced in 1983 and all common stocks, bonds and etfs are traded like S&P 500. it indicates well the health of the economy of korea. Kosdaq benchmarekd NASDAQ, which is electronic screen-based equity securities trading market. It facilities flow of funds to small, medium and venture corporations.
  • Participants; well divided between, foreigner, individual and other corporations. May be we need a figure of ASXFocus on foreign investors, from the perspective of foreigners, they want to diversify their portfolio by investing in mining indutry.
  • Here is the market cap and number of listed companies by industry sectors. As you can see, electronic equipment and finance are the major players. And there is only one mining company listed.Market cap is huge compared to number of firms, samsung, lg.Dominating krx, marketcap< number,
  • Concentreation.Whereas metal and mining sector is the major player on asx.
  • HERE IS THE MARKET CONCENTRARION SLIDE. WE ANALYSED THE TOP 5% AND TH 10 MOST HEAVILY CAPITALIZED AND TRADED DOMESTOC COMPANIES..Market concentration shows the part represented by 5% of the most heavily capitalized domestic companies and 5% of the most traded domestic shares compared to domestic market capitalization and share trading value, respectively.It also indicates the part represented by the 10 most capitalized domestic companies and the 10 most traded ones compared to domestic market capitalization and share trading value, respectively.
  • AS YOU CAN SEE, ASX IS MORE CONCENTRADED THAN KRX AND when it come to trading value around 90% is from top 5% firms. This is telling that KRX is more diversified so that smaller firms maybe receive more attention from investors.Number of companies:asx 91, krx 89Both market are concentrated in terms of market cap and trading value.Trading value: top 5% firms from ASX takes up nearly 90% of all trading activities.Reason: huge companies in ASX (BHP, Telstra, Big 4 banks…) ; it seems that smaller stocks are not traded at all. This is not the case for KRX. Go back to first slide: why trading value is higher in Korea.We then try to look into even smaller number of firms: top 10 firms
  • Similarities: promote execution speedWE WANT HERE TO EMPHASIZE OF THE SPECIAL CHARACTERISTICS OF KRX. YOU MAY ALREADY KNOW OF ASX VERY WELL AT THIS STAGE. KRX HAS A CIRCUIT BREAKERS MECHANISM. for instance KOSPI FALLS BY 10% and stays more than 1 minute, the exchange activates trading restriction for 20 minutes. Only used once per day to prevent the collapse of the equity market. And we have found that krx has more price control mechanisms than asx. This is because the volatility of equity market is bigger than ASX whis is known well-stabilized equity market. The other characteristic is the block trading system. Krx allows the bloack traders to submit their limit orders after-hours trading. It should be no more than1.75% from closing price. It could reduce the market impact cost for the traders however, opportunity cost still remains.
  • http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aiSWLUijYm_ghttp://news.alibaba.com/article/detail/markets/100074124-1-south-korea-reviews-short-selling-ban.htmlhttp://www.dsf.nl/assets/cms/File/Research/DSF-TI%20Discussion%20Paper%20No%201%20Short-selling%20bans%20around%20the%20world%20Jan%202010.pdf
  • Here is the brief of trading activities statistics. LETS go back to the first slide. Asx market cap>krx. Whereas krx’s trade valu>asx which comes from the total number of trades. Interestingly the average value of trades in asx is much higher than KRX. WHAT IT TELLS US THAT KOREAN INVESTORS TRADE MORE OFTEN THAN AUSSIE BECAUSE WE CAN THE DIFFERENCE OF NUMBER OF TRADES. IS THAT BECAUSE KOREAN INVESTORS ARE MORE ACTIVE? OR IS THIS POPULATION EFFECT SINCE THE NUMBER OF AUSSIE IS HALF OF TOTAL NUMBER OF KOREA?. OR IS THERE TRANSACTION ISSUE? WE ANALYSED THE BROKERAGE FIRMS. SLIDES NEEDED.The average daily turnover is calculated by dividing the total value of share trading by the number of trading days during the year.The average value of trades during a given year is calculated by dividing the total value of share trading by the total number of trades in equity shares.Obviously, there is a high turnover rate in KRX. -> and the value is smaller than ASX. Does that mean korean investors less patiesnt? More active investors? Population effect? Equity participating population? Or institutional investor split the order to small parcel? Simply a lot of retail investor? Depth of liquidity low transaction fee?Asx too expensive for retail investors , so they put in larger order? Retail investors may stay away from asx
  • No flat fee for Korea
  • Compare min tick size to price of stockTick size is higher on, or lower on…
  • What to say here: Let’s come our journal article. As you can see we chosen the article “Market Structure, fragmentation, and market quality” by Paul Bennet from Journal of Financial markets which is one of the top journals in market micro structure!-------------------------------------------------------------------------------------------------------------------------------------------------We need to change sth. on the picture because the writing is not clear now!
  • What to say:Before we start to analyse the purpose of paper and our motivation for the paper, we would like to give you a brief overview about the content. What they did was: they examined 38 stocks that recently (2002 and 2003) changed their listing from the NASDAQ to NYSE. In particular they looked at how does the intraday volatility change, how does the spread change. These factors amongst others are known as market quality Well an in addition to this they tried to find our what is the reason for this difference and they came with the idea that order fragmentation could be one reason for a lower market quality on NASDAQ-------------------------------------------------------------------------------------------------------------------------@Tai: i include one summary slide at the beginning since I think, for the audience it is good to know some of the paper’s content before we go into to much detail wit research question etc..... What do you think
  • @ Tai: Please try to make a nice chart out of this, or probably one inclusive diagram for all the information ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------What to say on this slide: Just real quick since this paper is dealing with the NASDAQ and NYSE. Well most striking difference is that on the NYSE there is a monopoly structure while there are a lot of market centres on the NASDAQ as you can see in the chart below. You have NASDAQ Supermontage, Regional Exchanges and ECN, and this leads to a high order fragmentation.
  • What to say for this slide: So why did we chose this article why do we think the topic is relevant?Well the topic covered goes back to very basic question. What is the optimal market design to facilitate the flow of funds. Should markets rather be organizes like the NYSE with its monopolistic structure or like NASDAQHow does this market structure impact the price efficiency the volatility and the spread. Because we as traders should be very concerned about this. Since one of the key goal is to minimize TC and one part of TC is the Spread. --------------------------------------------------------------------------------------------------------------We need some picture of NYSE and NASDAQ, I am not fully happy with the formulation of my sentencesDo you think we should also refer to transaction costs, since spread is significantly lower on NYSE
  • What to say here: Little bit more information on the research question. It is an empirical paper, therefore they want to investigate whether there is a difference. And if there is a difference what is the reason for this difference. Especially in the second part of the paper they focus on the issue of order flow fragmention. They want to examine whether the improvement in market quality is due to the fragmented order flow on the NASDAQ. So is more prior to switch order fragmentation related to a higher magnitude of the improvement.
  • Remove VertikalaxxesLet’s come to how they examined the before named research question; They used a natural experiment of stocks that switched! Therefore there is no noise through firm specific effects. If you simply look at the spread between NYSE and NASDAQ your result might be biased through firm specific effects, since the firms that list on NASDAQ and NYSE might just be different They found out that the intraday 5 minute short term volatility fell by 25% and the 5 minute price high low ratio, another measurement for volatility even falls by 50%For the spread as you can see very similar results. But one thing we found pretty interesting. The improvement in spread is particularly high at the beginning and –important in this case- at the end of trading. This is quite an interesting result since it actually contradicts the finding of “Market structure and the intraday pattern of bid-ask spread for NASDAQ securities” by Chan et al. You should all know this paper since it is in the reading list. They found out that in general due to competition the spread narrows on the NASDAQ at the end of trading. We touch on this again later in this presentation. How to present this slide: Go over the slide real Compare the results to the Chan Christie Schulz paper. ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------Spreads are stable throughout the day but narrow near close. Contrast with U-shape in NYSE. Attributed to structural difference between specialist (NYSE) and dealer markets (NASDAQ).London Stock Exchange: also quote-driven, decline intraday spreadsInstitutional: determine intraday spreadsNYSE U-shape: market power of specialist (privileged knowledge, exploit inelastic demand), cost of adverse selection, discretionary liquidity traders1st structural difference: NASDAQ spreads remain constant during first hour. NYSE spreads decline. NYSE specialist ability to exploit market power decline after investors' demand becomes elastic
  • To the price efficiency: decline in volatility improves market quality primarily to the extend that it eliminates price movements that are noisy and extraneous form those that the reflect the arrival of new information. They use three measures here: variance decomposition, Variance ratio test and autocorrelation. I want to explain autocorrelation on the black board. Result is clear they found highly significant autocorrelation on the NASDAY and no significant correlation on the NYSE!My explanation will be to write an example of a perfectly efficient market with the normal market. With the test for autocorrelation they extract the underlying movements form the random effect on new fundamental information; Autocorrelation : Price t = Beta * Price of t-1 plus ErrortermProxies for the improvement in market quality are: 5 minute standard deviation, change in quoted spread and change in effective spreadLiquidity simply refers to the trading volume prior to the switch Proxies for Market Fragmentation are the HHI (Herfindahl Hirschman Index, the number of market centers, the HHI ratio (NASDAQ HHIO/NYSE HHI) and log number of market center ratioThe result is clear: higher market fragmentation is significantly at the 1% level related to the magnitude of the market quality improvement ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------Do you think we should explain autocorrelation on the board or on the slides. I personally would prefer to do it in class. The relation of market fragmentation and the magnitude of improvement was done by OLS! Do you think we should write this down?[Tai] do it on white board
  • Maybe conclusion at the very end? What do you think Tai?[Tai] conclusion at end has good impact on audience but it does not look like standard research paper flow. I need to think about this[Stefan] what do you think now?---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------So on a more general basis what is the paper trying to teach us. What advise does it give us. First, having in mind the Schulz paper as well there is definitely a tradeoff between order consolidation and competition. For small stocks the benefit of order consolidation is more beneficial than the one of increased competition., but this might not be the case for large stocks Draw on Whiteboard:
  • Maybe TAI can present this slide--------------------------------------------------------------------------------------------------------79’ Journal of Finance paper by Hamilton touches on the tradeoffhttp://www.jstor.org/stable/2327151?seq=2
  • Maybe TAI can present this slide
  • Image: http://shinyisland.files.wordpress.com/2010/02/snsd-hanboks1.jpg


  • 1. Korea Stock Exchange& Australian Stock Exchange
    Stefan Binder
    Harry Jang
    Tai Tran
  • 2. ASX
    Market Cap
    Trade Value
  • 3. Background Information
    Founded 1956
    2005: Korea Stock Exchange, Korea Futures Exchange and KOSDAQ integrated
    17th by Market Cap (0.84 trillion)
    8th by Trade Value (1.6 trillion)
    1st in derivatives trading
    2nd in liquidity (trading value scaled by MCap)
    KOSPI(Korea Composite Stock Price Index)
    Introduced in 1983
    All common stocks, bonds and ETFs traded
    770 firms listed
    KOSDAQ(Korean Securities Dealers Automated Quotations)
    Established in 1996, benchmarked NASDAQ
    Electronic screen-based securities trading market
    Provides flow of funds to small, medium and venture corporations
    1011 firms listed
  • 5. source: WFE
  • 6. source: WFE
  • 7. source: ASX
  • 8. Market concentration
    Top 5% companies
    KRX 89 companies
    ASX 94 companies
    10 largest companies by market cap
  • 9. source: WFE
  • 10. Price Discovery
    Best Practice
    • Order-driven: Consolidated, liquidity
    • 11. Market makers for derivatives: promote liquidity
    • 12. Call to maximize number of trades: fairness
  • Trading System
    Circuit breaker: trading halt
    No circuit breaker
    Most stable exchange 1999-2009
    Off-Market Trading
    • KRX
    • 13. Price no more than ±1.75% from closing price, within lowest & highest price of day
    • 14. ASX
    • 15. Institutional investors
    • 16. $1m
    • 17. Not for retail investors
  • The Ban on Short-Sale
    KRX: Oct 2008 - Jun 2009
    ASX: Sep 2008 - May 2009
    Buy Puts  less impact from derivatives
  • 18. Trading Activities
    source: WFE
  • 19.
  • 20. Listing Requirements
    Size test A$19,000
    Minority holding
    At least 5% and A$930,000 offered
    No. of owners with voting right at least 1,000
    Financial test (1 of 3)
    Sales A$27m + Profit A$2.3m + ROE 5%
    Sales A$46m + MCap A$93m
    Sales A$65m + Mcap A$46m + OCF A$1.9m
    More focus on financial performance
    Size test A$10m
    Profit test A$1m
    Shareholding: 500 x $2,000 or 400 x $2,000 and 25% held by unrelated parties
    Asset test: tangible A$2m, working capital A$1.5m
  • 21.
  • 22. Tick Size
  • 23. Regulation
    KRX facilitates trading
    Financial Supervisory Service (gov)
    ASX facilitates trading
    ASIC (gov) & ASX co-regulate
  • 24. Summary & Suggestions
    KRX Summary
    Smaller (MCap) but much more active
    More diversified
    Cheaper to list and trade
    More price control
    Suggestions for ASX
    Review fee structure
    Reduce tick size
    Joint venture programs
  • 25. Market Structure, Fragmentation, and Market Quality
    Paul Bennett & Li Wei
    Journal of Financial Markets
  • 26. Brief Summary
    Examined a sample of 38 stocks that switched from NASDAQ to NYSE
    Significant Improvement in Market Quality
    Order Flow Fragmentation affects the market quality, especially for less liquid securities
  • 27. Order Flow Fragmentation
  • Motivations
    Optimal market design to facilitate the flow of funds: NYSE vs. NASDAQ/ Monopoly vs. Competition
    Impact of market structure on market quality (spread, volatility, price efficiency)
    Same securities on different markets, different market quality: why?
    Traders: Where to trade & minimize Transaction costs
  • 35. Research Questions
    Difference in spread, volatility, price efficiency between NYSE and NASDAQ?
    Reason for this difference?
    Impact of order flow fragmentation on market quality improvements
  • 36. Method/Results
    Recent sample of 38 small and less liquid stocks that switched from NASDAQ to NYSE
    • Huge improvements beginning and end of trading
    • 37. Contradicts Chan et al 1995 paper!
    • 38.  Trade-off between order fragmentation and competition
  • 39. Methods/Results
    Improvements in Price Efficiency
    Degree of market fragmentation prior to the switch related to the magnitude of market quality improvement
    Liquidity (Trading Volume) negatively related to improvements
  • 40. Conclusion
    Trade-off between competition and order fragmentation
    NYSE organisation with market maker more suitable for small less liquid stocks
    NYSE might be better for dealing with shocks where there is less liquidity in general (Flash Crash)
  • 41. Critiques
    Clear practical relevance (reducing Transaction costs, where to trade?)
    Contradicts Chan et al. Paper
    Some of the results proven before, so little new information
    But important to revaluate this question since NASDAQ structure changes continuously
    Convincing evidence that order flow fragmentation causes lower market quality
  • 42. Questions that remain
    Whether this effect is consistent across all size categories
    Further examine the Trade off
    Other aspects (apart from order fragmentation) that contributes to optimal market design, i.e. Minimum Tick, Trading Protocols
  • 43. Questions