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PHDBA 239DA - Financial Market Microstructure is a PhD level course that is required for finance students. This page details the course as it was taught by Christine Parlour in the Spring of 2011.


The following class overview was taken from the course outline:

This is a 7 week course in market microstructure. Market Microstructure
is the study of the price formation mechanism. It also typically addresses
what we can learn from prices (i.e., the information content of a trade).
In finance as we are obsessed with prices, studying how they arise from
agents' strategic behavior seems a sensible place to start. As data are readily
available, there is a voluminous empirical literature. Given that a lot of the
models are very stylized and the operation of the markets so complex, the
empirical work is aggressively reduced form. Needless to say, I won't cover
the empirical work as this does not represent my comparative advantage.
After the crisis, researchers in other fields (asset pricing) are beginning to
understand that understanding the mechanics of trade is important. I will try
to address how some of the ideas of microstructure have been incorporated
into the other fields. Given the brevity of the course, this list is both short
and idiosyncratic.


The class is evaluated on:

  1. A referee report on current working paper
  2. A 2-5 page paper proposal
  3. Three optional assignments

Sequence of Topics

The following sequence is in the outline:

  • Jan 19 - Rational Expectations Models
  • Jan 26 - Classic Models I
  • Feb 2 - Classic Models II
  • Feb 9 - Limit Order Markets
  • Feb 16 - Fixed Income Markets
  • Feb 23 - Liquidity and Asset Prices
  • March 2 - Liquidity, Trade and Contracts


Classic Market Microstructure

General Surveys of the Field

  • O'Hara, Maureen (1995), "Market Microstructure Theory", Blackwell (This is a book.) (link)
  • Biais, Bruno, Larry Glosten and Chester Spatt (2005), "Market Microstructure: A Survey of Microfoundations, Empirical Results, and Policy Implications", Journal of Financial Markets 8, May 217-264. (pdf)
  • Parlour, C. and D. Seppi (2008), "Limit Order Markets: A Survey", Handbook of Financial Intermediation and Banking (pdf)
  • Brunnermeier (2001), "Asset Pricing under Asymmetric information: Bubbles, Crashes, Technical Analysis, and Herding", Oxford University Press (pdf)
  • De Jong F. and B. Rindi (2009), "The Microstructure of Financial Markets", Cambridge University Press. (link)

Stylized Models of Trade (Rational Expectations)

  • Grossman and Stiglitz (1980), "On the Impossibility of informationally efficient markets", American Economic Review Vol 70, pp.393-408. (pdf)

What is Needed to Generate Trade

  • Milgrom and Stokey (1982), "Information, Trade and Common Knowledge", Journal of Economic Theory, 26, 17-27. (pdf)
  • Aumann (1976), "Agreeing to Disagree", Annals of Statistics, 4, 1236-239. (pdf)
  • Akerlof (1970), "The Market for Lemons", Quarterly Journal of Economics, Vol 84, No 3, p488-500. (pdf)
  • Ausubel (1990), "Insider Trading in a Rational Expectations Economy", The American Economic Review, Vol 80, No 5 1022-1041. (pdf)
  • Myerson and Sattherthwaite (1983), "Efficient Mechanisms for Bilateral Trade", Journal of Economic Theory, 29, 265-281 (pdf)

Classic Microstructure Models

  • Glosten and Milgrom (1985), "Bid, Ask and Transaction Prices in a Specialist Market with Heterogeneously Informed Trades", Journal of Financial Economics, 13, 71-100. (pdf)
  • Kyle (1985), "Continuous Auctions and Insider Trader", Econometrica, 3, 1315-1336. (pdf)
  • Kyle (1989), "Informed Speculation with Imperfect Competition", Review of Economic Studies 56, 317-355 (pdf)
  • Amihud and Mendelson (1980), "Dealership Markets: Market Making with Inventory", Journal of Financial Economics, 8, 31-53 (pdf)
  • Easley, D. and M. O'Hara (1987), "Price, Trade Size and Information in Securities Markets", Journal of Financial Economics 19, 69-90. (pdf)

Limit Order Markets

  • Rock, K. (1996), "The Specialist's Order Book and Price Anomalies", working paper, Harvard University. (This paper is legendary but not available online!)
  • Seppi, Duane (1997), "Liquidity Provision with Limit Orders and a Strategic Specialist", Review of Financial Studies 10, 103-150. (pdf)
  • Glosten, Larry (1994), "Is the Electronic Open limit Order Book Inevitable", Journal of Finance 49,1127-1161 (YES) (pdf)
  • Parlour (1998), "Price Dynamics in a Limit Order Market", Review of Financial Studies 11 789-816 (pdf)
  • Foucault (1999), "Order Flow composition and Trading Costs in a Dynamic Limit Order Market", Journal of Financial Markets (pdf)
  • Foucault, T., O. Kadan and E.Kandel (2005), "Limit Order Book as a Market for Liquidity", Review of Financial Studies, 18, 1171-1217. (pdf)
  • Goettler, R., C. Parlour and U. Rajan (2005), "Equilibrium in a Dynamic Limit Order Market", Journal of Finance, 2005, Vol 60 No 5 p149-192 (pdf)
  • Back, Kerry and S. Baruch (2005), "Working Orders in Limit-Order Markets and Floor Exchanges", Journal of Finance (pdf)
  • Rosu, I. (2005), "A Dynamic Model of the Limit Order Book", U Chicago working paper. (pdf)

Market Design and Competition between Markets

  • Biais, Bruno (1993), "Price Formation and Equilibrium liquidity in Fragmented and Centralized Markets", Journal of Finance 48, 157-185. (pdf)
  • Biais, B., D. Martimort and J. Rochet (2000), "Competing Mechanisms in a Common Value Environment", Econometrica 68, 799-838. (pdf)
  • Parlour and Seppi (2001), "Liquidity based Competition for Order Flow", Review of Financial Studies. (pdf)
  • Foucault, Thierry and T. Gehrig (2008), "Stock Price Informativeness, Cross-Listings and Investment Decisions", Journal of Financial Economics 88, 146-168. (pdf)
  • Foucault, Theirry and A. Menkveld (2008), "Competition for Order flow and Smart Order Routing systems," Journal of Finance 63, 119-58 (pdf)

Is trading risk or liquidity priced?

  • Acharya, Viral and L. Pedersen,(2005), "Asset Pricing and Liquidity Risk", Journal of Financial Economics, Vol 77, pp 375-410 (pdf)
  • Amihud, Yakov and Haim Mendelson (1986), "Asset Pricing and the Bid Ask Spread", Journal of Financial Economics, 17, 31-56 (pdf)
  • Amihud, Y., H. Mendelson, and L, Pedersen (2005), "Liquidity and Asset Prices", Foundations and Trends in Finance I. 269-364 (pdf)
  • Brennan, M. J. and A. Subrahmanyam (1996), "Market Microstructure and Asset Pricing", Journal of Financial Economics 41, 441-464 (pdf)
  • Easley, D. S. Hvidkjaer and M. O'Hara (2002), "Is information risk a determinant of Asset returns", The Journal of Finance 58, 2185-2210. (pdf)
  • Pastor, L. And R. Stambaugh (2003), "Liquidity risk and Expected Stock Returns", Journal of Political Economy, 111, 642-685. (pdf)
  • Chordia, T. R. Roll and A. Subrahmanyam (2000), "Commonality in Liquidity", Journal of Financial Economics, 56, 3-28. (pdf)
  • Chordia, T. R. Roll and A. Subrahmanyam (2001), "Market Liquidity and Trading Activity", Journal of Finance, 56, 501-530. (pdf)
  • Grossman, S. and Miller, M. (1988), "Liquidity and market structure", Journal of Finance 38, 617-633. (pdf)
  • Holmstrom, B. and Tirole, J. (2001), "LAPM - a liquidity based asset pricing model" (pdf)
  • Easley, David and M. O'Hara (2004) - "Information and the cost of capital", Journal of Finance Vol.59, No 4. p 1553-1583. (pdf)

Slow Moving Capital and Asset prices

  • Gromb, Denis and Vayanos, Dimtri (2002), "Equilibrium and Welfare in Markets with Financially Constrained Arbitrageurs", Journal of Financial Economics (pdf)
  • Duffie, Darrell, Semyon Malamud and Gustavo Manso (2009), "Information Percolation with Equilibrium Search Dynamics", Econometrica, Volume 77: 1513-1574. (pdf)
  • Brunnermeier, Marcus and L. Pedersen (2009), "Market Liquidity and Funding Liquidity", The Review of Financial Studies 22, p. 2201-2238 (pdf)

Treasury Auctions

  • Wilson (1979), "Auctions of Shares", Quarterly Journal of Economics, Vol 93 No 4. p 675-689. (pdf)
  • Back and Zender (1993), "Auctions of Divisible Goods", Review of Financial Studies, 6 p733-764. (pdf)
  • Wang and Zender (2002), "Auctioning Divisible goods", Economic Theory, 19, 673-705.(pdf)
  • Kremer, and Nyborg (2004), "Underpricing and Market Power in Uniform Price Auctions", Review of Financial Studies, 17, 849-877 (pdf)
  • Nyborg and Strebulaev (2004), "Multiple Unit Auctions and Short Squeezes", Review of Financial Studies 17, 545-580 (pdf)
  • Bikhchandani and Huang (1989), "Auctions with Resale", Review of Financial Studies, Vol 2, no3 p311-339 (pdf)
  • Vickery, William (1961), "Counterspeculation, Auctions and Competitive Sealed Tenders", Journal of Finance (pdf)

Fixed Income Microstructure

  • Duffie, D. N. Garleanu, and L. Pedersen (2005), "Over the Counter Markets", Econometrica 73, 1815-1847 (pdf)
  • Biais, Bruno and Rick Green (2007), "The microstructure of the Bond Market in the 20th Century" (pdf)
  • Biais, Bruno, Fany Declerk, J. Dow, E. Van Thadden (2006), "Transparency, Liquidity and Information in Dealer markets", Working paper (link)
  • Green, Rick, B. Hollifield, and N. Schurhoff (2007), "Dealer Intermediation and Pice Behavior in the aftermarket for new bond issues", Journal of Financial Economics (pdf)
  • Green, Rick, B. Hollifield, and N. Schurhoff (2007), "Financial Intermeidation and the costs of trading in an opaque market", Review of Financial Studies. (pdf)
  • Vayanos, Dimitri and P.O. Weill (2008), "A search based theory of the on-the-run phenomenon", Journal of Finance 63, pp.1361-1398. (pdf)

Liquidity, Trade and Contracts

  • Chemla, G. and C. Hennessey (2010), "Security Design, Liquidity and the Informational Role of Prices", Working paper (pdf)
  • Chemla, G. and C. Hennessey (2010), "Privately optimal Securitization and Publicaly Suboptimal Risk Sharing" (pdf)
  • Edmans, Alex and G. Manso (2011), "Governance Through Trading and Intervention: A Theory of Multiple Blockholders", Review of Financial Studies, forthcoming. (pdf)
  • Faure-Grimaud, Antoine and D. Gromb (2004), "Public Trading and Private Incentives", Review of Financial Studies 17(4) 985-1014 (pdf)
  • Parlour, C. and G. Plantin (2008), "Loan Sales and Relationship Banking", Journal of Finance, Volume 63(3), 1291-1314. (pdf)
  • Admati, Anat and Paul Pfeiderer (2009), "The Wall street Walk and Shareholder Activism: Exit as a Form of Voice", Review of Financial Studies, 22 (7), pp.2645-2685. (pdf)