Page 724 - Encyclopedia of Business and Finance

eobf_S 7/5/06 3:21 PM Page 701

Stock Exchanges

trading volume, given order submission at the time of the quality, and (5) a clearing function to ensure timely pay-
auction. In most computerized markets, traders submit ment and delivery of shares. The product offered to
orders to a central limit order book, and a mathematical investors consists of a combination of liquidity and pric-
algorithm determines prices and quantities. Examples ing information, as well as any benefits accruing to the
include the CAC system of the Paris Bourse and the OM investor from the bundle offered to companies.
system of the Stockholm Stock Exchange. Government regulation and increased competition
from automated-trading systems lessen the importance of
MARKET INTERMEDIATION exchange monitoring and standardized rules. Technologi-
cal advances in information processing allow better signals
Investors are generally not given free access to trading sys-
tems. Entry into the exchange’s systems is intermediated about company quality than simple listings, permit wide
by brokers. Brokers may simply route orders to exchanges. distribution of pricing information outside exchanges,
They sometimes make decisions as to what exchange, and and enable separation of the clearing function from other
what system within the exchange, should process various exchange operations. The result is that exchanges now
parts of an order. In open outcry markets, brokers also compete solely along the dimensions of liquidity and cost
of trading.
physically represent orders on the floor of the exchange.
Competition through liquidity and cost has led to
Another class of intermediaries is known as market
increased automation of the exchange trade-execution
makers. Market makers trade for their own accounts, usu-
process. Automated exchanges are less costly to build and
ally providing an offer to sell and an offer to buy at the
operate, and provide lower-cost trade execution. Liquidity
same time, but at different prices. In doing so, they both
is enhanced by the ability to establish wide networks of
contribute to the pricing process and supply immediacy to
the market by a willingness to be a counterparty to an traders through communications systems with an auto-
order for which another investor may not be immediately mated-execution system at the nexus. The drive for
increased liquidity through computerization has led to
available.
new developments in the structure of the exchange serv-
On some exchanges, most notably the NYSE, there is
ices industry, most notably including mergers and
one primary market maker designated by the exchange,
alliances between automated exchanges for increased
known as the specialist. The specialist obtains considera-
order flow.
tion for the supply of immediacy and the maintenance of
Communications technology and the computeriza-
an orderly market by having private access to order-flow
tion of trade execution have also globalized trading. The
information through the order book for the stock.
physical location and boundaries of an exchange floor are
There may be multiple market makers in a given no longer important to traders. A company does not need
stock, regardless of the precise form of trading system. The to be listed, or even traded, on a domestic exchange. Not
prototype example is that of dealer markets, in which the only are there many possible execution services providers,
dealers are the market makers. They post bids and offers, but electronic exchanges place their own terminals on for-
and trade out of their own inventory. eign soil, allowing direct access to overseas listings, regard-
Electronic-limit order-book markets offer the possi- less of the nationality of the companies involved.
bility of trading without such financial intermediation. In
practice, however, market makers exist on electronic mar- GOVERNANCE
kets as well. Multiple market makers in a security are often
designated by an exchange, fulfill obligations not dissimi- The organizational structures commonly found for
lar to those of a specialist, and receive some consideration exchanges are: nonprofit, the consumer cooperative, and
for-profit. Historically, most exchanges have been non-
for the service. Anyone with direct access to the trading profit organizations, but since the 1990s, there have been
system can function as a market maker, however, simply trends toward incorporating an exchange as a for-profit
by continuously offering quotes for stock on both sides of
organization. Ten such demutualizations globally are
the market.
listed in Ian Domowitz and Benn Stell’s article, “Automa-
tion, Trading Costs, and the Structure of the Securities
COMPETITION Trading Industry” (1999), and such initiatives are under
Exchanges have two clienteles: companies, which list their investigation by many traditional exchanges, including
shares, and investors, who trade on the exchange. Histor- NASDAQ and the NYSE. The NYSE approved its inten-
ically, the product (a listing service) offered to companies tion of becoming a publicly traded entity after its merger
was a bundle, consisting of (1) liquidity, (2) monitoring of with the Archipelago exchange as of early 2006. (The
trading against forms of fraud, (3) standard-form rules of merger was approved in December 2005.) Archipelago is
trading, (4) a signal that a listing firm’s stock is of high an electronic trading platform that owns the Pacific Stock

ENCYCLOPEDIA OF BUSINESS AND FINANCE, SECOND EDITION 701