Market microstructure is the study of how asset prices adjust to reflect new information through the trading process under a market's explicit trading rules. It examines how trading rules and strategies affect price changes over time and how investors' valuations are incorporated into prices. The trading system, whether it uses a call market or continuous trading, hybrid models, and trading hours all define a market's microstructure and impact the price discovery process. Market microstructure has important implications for traders, exchanges, regulators, and policymakers.

2. What is market microstructure?
Traditional asset pricing aims to understand
what should be the price of a security.
It does not, however, address how prices
adjust to reflect news.
Nor does it explain how investors’ subjective
assessment of a security “get into” the price.

3. Market structures
• The trading rules and the trading systems define a market’s
market structure.
• Call markets versus continuous markets.
– Call markets allow trades only when the market is called (rotation
among securities).
– Continuous markets allow trades anytime during regular trading hours.
– Hybrids of course exist (NYSE, the LSE and soon Nasdaq)
– Which one would you prefer, and why?
• Trading hours.
– Most markets limit their regular trading hours.
– Should markets be open around the clock?

4. In practice, news and investors’ valuations are
incorporated into security prices through
trading.
This means that the specific trading rules, and
the strategies traders develop in response to
these rules, will affect how asset prices
change over time in response to new
information.

5. Market microstructure is the study of the
process and outcomes of exchanging assets
under explicit trading rules.” (Maureen
O’Hara, a former president of the American
Finance Association)
Market microstructure has a profound impact
on the real world – on traders, broker/dealers,
exchanges, regulators, and policy makers alike.

6. Why do we care?
Data guided by theory, theory guided by data
Market design issues
Agency auction market
Dealer market
Electronic limit order books

7. Market performance issues
–Transaction costs
–Shock absorption/resiliency
–Trading halts
Efficiency – welfare issues
–Is insider trading bad?