Market Microstructure and Spread Pattern in the JASDAQ Market
- This paper is an English translation of the Japanese original released in March 2002.
June 18, 2002
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Firms listed on JASDAQ can select either the order-driven (hereafter OD) system, where formal market makers are not involved, or the market-maker (hereafter MM) system for the trading of stocks. How differences in trading systems affect pricing and liquidity is a key issue in the study of market microstructure. This paper examines empirical analyses of spread patterns for stocks listed on JASDAQ in order to ascertain the implications of differences in trading systems on price formation.
For MM issues, two-way prices are quoted for most of the trading day irrespective of market capitalization, spreads are stable, and their standard deviation is tighter than for OD issues. MM issue spreads tend to be wider than two ticks, but the percentage of trades executed within spreads is higher than that of OD issues at about 30 percent. In other words, the average effective spread for MM issues, calculated from execution prices and prevalent spreads, tends to differ from the average observed spread.
For OD issues, there is a risk that orders cannot be executed at the desired timing as quotes may not always be available, and the average spread is twice as wide than is the case for MM issues. Nevertheless, the ability of potential buyers/sellers to adjust bid/ask prices could lead to narrower spreads when potential buyers/sellers requiring the quick execution of orders raise/lower bid/ask prices. That is, OD issue spreads are influenced by individual market participants who, emphazing execution prices, place limit orders.
A difference in spread patterns was observed not only through comparative analyses of MM and OD issues but also through analyses of changes in spreads before and after issues switched trading system. Such difference stems from differences in the behavior of market participants placing orders for OD issues and that of market makers.
In particular, the behavior of market makers may be influenced by the existence of the Small Trade Execution System and "leave order" system for MM issues, as has been noted in empirical studies in the US.