Jeffrey H. Harris

Effects of Market Reform on the Trading Costs and Depths of Nasdaq Stocks

The relative merits of dealer versus auction markets have been a subject of significant and sometimes contentious debate. On January 20, 1997, the Securities and Exchange Commission began implementing reforms that would permit the public to compete directly with Nasdaq dealers by submitting binding limit orders. Additionally, superior quotes placed by Nasdaq dealers in private trading venues began to be displayed in the Nasdaq market. We measure the impact of these new rules on various measures of performance, including trading costs and depths. Our results indicate that quoted and effective spreads fell dramatically without adversely affecting market quality. Copyright The American Finance Association 1999.

The Trading Profits of SOES Bandits

SOES bandits are individual investors who day-trade primarily through Nasdaqs Small Order Execution System (SOES). They attempt to predict short-term price movements of Nasdaq stocks by observing trades and changes in market maker quotes. We find that they usually hold positions for only a few minutes and usually trade profitably. They do not exploit single market makers who have failed to update quotes, but usually trade before the majority of dealers change quotes. It is intersting that SOES bandits trade profitably against dealers who have as much or more information. We attribute this to the greater incentives of the bandits. Market makers are trading with the firms money while SOES bandits are trading with their own.

Nasdaq Trading Halts: The Impact of Market Mechanisms on Prices, Trading Activity, and Execution Costs

We study the effects of alternative halt and reopening procedures on prices, transaction costs, and trading activity for a sample of news-related trading halts on Nasdaq. For intraday halts that reopen after only a five-minute quotation period, inside quoted spreads more than double following halts and volatility increases to more than nine times normal levels. In contrast, halts that reopen the following day with a longer 90-minute quotation period are associated with insignificant spread effects and significantly dampened volatility effects. These results are consistent with the hypothesis that increased information transmission during the halt results in reduced posthalt uncertainty.

Fundamentals, Trader Activity and Derivative Pricing

We identify and explain a structural change in the relation between crude oil futures prices across contract maturities. As recently as 2001, near- and long-dated futures were priced as though traded in segmented markets. In 2002, however, the prices of one-year futures started to move more in sync with the price of the nearby contract. Since mid-2004, the prices of both the one-year-out and the two-year-out futures have been cointegrated with the nearby price. We link this transformation to changes in fundamentals, as well as to sea changes in the maturity structure and trader composition of futures market activity. In particular, we utilize a unique dataset of individual trader positions in exchange-traded crude oil options and futures to show that increased market activity by commodity swap dealers, and by hedge funds and other financial traders, has helped link crude oil futures prices at different maturities.

Speculators, Prices and Market Volatility

We employ data over 2005-2009 which uniquely identify categories of traders to test whether speculators like hedge funds and swap dealers cause price changes or volatility. We find little evidence that speculators destabilize financial markets. To the contrary, speculative trading activity largely reacts to market conditions and reduces volatility levels, consistent with the hypothesis that speculators provide valuable liquidity to the market. These results hold across a variety of products and suggest that hedge funds (with approximately constant risk tolerance as in Deuskar and Johnson [2010]) improve overall market quality.

Effects of Central Bank Intervention on the Interbank Market During the Subprime Crisis

We explore whether central bank intervention improves liquidity in the interbank market during the current subprime crisis with unique trade and quote data from the e-MID, the only regulated electronic interbank market in the world. Central bank intervention consistently creates greater uncertainty in the interbank market. Prior to the crisis, the cover-to-bid ratio effectively conveys good and bad news from the central bank, but this link is broken during the crisis, suggesting that standard (and special) interventions that do not specifically target interbank asymmetric information fail to improve market liquidity. Our results suggest that the central bank should release stress tests for individual banks, provide interbank loan guarantees, or engage in direct asset purchases rather than simply providing more capital when counterparty risk poses systemic risk to the interbank market. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Informed Trading and Market Structure

We examine London Stock Exchange trading around information releases and link market quality dimensions with market structure during periods with heightened interaction between informed and uninformed traders. We find support for both the hypothesis that automated electronic markets minimise trading costs for liquid stocks and the hypothesis that adverse selection costs are minimised with intermediated trading. We examine how news affects both dealer and electronic systems and find that electronic markets are prone to greater stealth trading and post‐trade volatility, both consistent with the proliferation of algorithmic trading and short‐term volatility events such as the May 6, 2010 ‘flash crash.’

The Sound of Silence

Using comprehensive electronic data collected directly from NASDAQ systems, we assess the impact of changes in electronic message traffic on predicting short-term changes in prices, spreads and quoted depth levels. We document evidence that message traffic at, and nearby, the inside quotes predicts upcoming price and quoted depth changes as much as 75 seconds in advance. Controlling for the time series properties of silent information, past price, volume, electronic communication network volume, time-of-day, and firm-specific fixed effects, we find that message traffic is strongly related to short-term returns. Our results demonstrate that modern electronic trading systems can be employed by high-frequency traders to effectively forecast short-term market conditions.

The Role of Speculators During Times of Financial Distress

One of the best-known and largest hedge fund failures was the 2006 failure of Amaranth Advisors, LLC. The authors use detailed, trader-level data to examine the role of speculators during times of financial distress—in this case, the failure of Amaranth. They find that speculators served as a stabilizing force during the period by maintaining or increasing long positions, even while prices fell. The authors develop two testable propositions regarding liquidation versus transfer of positions and conclude that the probability of transfer was more likely for distant contract expirations and for contracts more dominantly held by the distressed trader. The article also examines the role of speculators in providing liquidity and mitigating the effects of liquidity risk by evaluating the change in the number of traders, the size and time between trades, and a Herfindahl measure of speculative trader concentration during the crisis period.

Trading networks: Trading networks

In this paper, we analyse the time series of 12,000+ networks of traders in the E‐mini S&P 500 stock index futures contract and we empirically link network variables with financial variables more commonly used to describe market conditions. We show that network variables lead trading volume, intertrade duration, effective spreads, trade imbalances and other market liquidity measures. Network variables reflect information, information asymmetry and market liquidity and significantly presage future market conditions prior to volume or liquidity measures. We also find two‐way Granger‐causality between network variables and both returns and volatility, highlighting strong feedback between market conditions and trading behaviour.