Financial Markets Microstructure - Lecture 1

Course Introduction

Course Title: Financial Markets Microstructure
University: University of Copenhagen
Lecturer: Igor Starkov (Assistant Professor)
Semester: Spring 2020
Mode of Delivery: Primarily online due to COVID-19
- 10 out of 16 lectures and 3 out of 5 exercise classes were held as live streams and recorded.
- Recordings of these classes are available on YouTube.
Course Material: Available on the lecturer's personal website (slides, problem sets, exams, reading list).
Textbook: The course is based on a textbook by Terry Foucault, Marco Pagano, and Ailsa Röell (published in 2013).
- First two-thirds of the course follow the textbook.
- Lecture 11 onwards focuses on research articles and becomes more creative.

Lecture Format: Unedited one-pass recordings to maintain quality consistency.
Exercises: Provided at the end of lectures, involving readings from sources like The Economist, Bloomberg, etc.
Final Exam: Not available yet, will be uploaded during summer 2020.

What Are Markets?
- A place (physical or digital) where property rights are exchanged.
- Example: Financial markets (stocks, bonds, derivatives).
Purpose of Markets: Efficient exchange of property rights to enhance social welfare.
Efficiency in Markets:
- Allocation of property rights should ideally go to those who value them the most.
- Importance of ensuring smooth market functioning for welfare improvement.

Definition: Markets for financial assets (e.g., stocks, bonds, derivatives).
- Specific to reallocating wealth over time and across different contingencies.
- Feature asymmetric information, unlike general markets.

Primary Markets: Allocation of savings to investment (e.g., IPOs, treasury auctions).
Secondary Markets: Reallocation of investments among traders (e.g., stock markets, bond markets, derivatives markets).
- Focus of the course primarily on secondary markets.

Market Prices & Trading:
- Prices emerge from demand and supply dynamics but depend on traders' behaviors and market environment.
- Includes informed trading based on asymmetric information.

Market Efficiency: Ensuring allocational efficiency where property rights are appropriately exchanged.
Market Liquidity: Ability to sell assets quickly without substantial price reductions.
- To be discussed in Lecture 2.
Market Depth: Measurement of order size required to change the asset price.
- Aspect of market liquidity.

Order-Driven Markets: Orders execute against each other (limit and market orders).
Dealer Markets: Central intermediary (dealer) facilitates trades.
- Example: NASDAQ
Classifications: Markets by trading organization and regulation (e.g., exchanges vs. OTC platforms).
- Example: New York Stock Exchange (NYSE) vs. dark pools of liquidity.

Types of Orders:
- Limit Orders: Specify quantity and price, stay in the limit order book until matched or canceled.
- Market Orders: Specify quantity, execute immediately at best available price.
Traders and Investors:
- Retail Investors: Individual amateur investors.
- Institutional Investors: Professional investors like pension funds, mutual funds.
- Informed vs. Uninformed Traders: Trading based on private information vs. idiosyncratic needs.
Intermediaries:
- Dealers/Market Makers: Provide market liquidity.
- Brokers: Facilitate trades between investors and market.

Objectives: Ensuring efficiency, protecting against insider trading, facilitating price discovery, and stabilizing markets.
Means: Order routing, transaction taxes, margin requirements, regulating algorithmic trading, etc.

Find share prices, bid and ask prices for popular stocks (e.g., Facebook, Microsoft). Identify corresponding stock exchanges.
Read the article on the London Metal Exchange and discuss the value of maintaining a physical trading floor in the digital age.
Solve exercises 1-3 from Chapter 1 of the textbook (if available).