Market Microstructure: The Components of Black-Box

Abstract

During the last few decades, market microstructure has become an important discipline within the field of finance. The market microstructure literature have been enriched by theoretical, empirical and experimental studies relating to other areas of finance such as assets pricing, corporate finance, international finance and welfare. The processes and rules of exchanging securities are considered an important issue since they affect the way in which trades are determined, prices are formed and scope of asymmetric information. However, the ways of describing how exchange process occurs in the markets are varied. This paper determines the components of the market microstructure black-box in terms of trading mechanisms and regulations governing various aspects of trading process. Determining the components of the black-box allows researchers to identify and compare the themes in market microstructure and issues facing the process of trading securities. Thus, this paper may be used as a source for future research ideas in comparing the market microstructure of exchanges. It also provides necessary input to the regulatory bodies to enhance the design of better markets. Furthermore, this paper would help the investors and portfolio managers to make better trading decisions by understanding how markets work and how it regulated as well as the investors will be able to interpret how various rules affect price efficiency, liquidity, transaction costs and trading profits.