Market microstructure

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Market Microstructure is a branch of economics concerned with the functional setup of a market. Typically this involves a financial market, and takes into account efficiency and liquidity. Practically speaking, major thrusts of market microstructure research look at the ways in which the working process of a financial market affects prices, volumes and trading behavior.

Maureen O’Hara Johnson, President-elect of the American Finance Association, defines market microstructure as “the study of the process and outcomes of exchanging assets under a specific set of rules. While much of economics abstracts from the mechanics of trading, microstructure theory focuses on how specific trading mechanisms affect the price formation process.”

The National Bureau of Economic Research has a market microstructure research group that, it says, "is devoted to theoretical, empirical, and experimental research on the economics of securities markets, including the role of information in the price discovery process, the definition, measurement, control, and determinants of liquidity and transactions costs, and their implications for the efficiency, welfare, and regulation of alternative trading mechanisms and market structures."

Microstructure covers market structure and design, price formation and price discovery, transaction cost and timing cost, and information and disclosure.

Price formation: This factor focuses on the process by which the price for an asset is determined.

Transaction cost & timing cost: This factor focuses on transaction cost and timing cost and the impact of transaction cost on investment returns and execution methods.

Market structure and design: This factor focuses on the relationship between price determination and trading rules.

Information and disclosure: This factor focuses on the market information and the impact of the information on the behavior of the market participants.

Felix Munnich, "Market Microstructure: Facts and Institutions", London School of Economics, Aug. 10, 2003

Giridhar, "Market Microstructure", Wipro Technologies White Paper

The National Bureau of Economic Research, www.nber.org

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