The Microstructure of Stock Markets

Abstract

We survey the literature analysing the price formation and trading process, and the consequences of market organization for price discovery and welfare. We develop a united perspective on theoretical, empirical and experimental approaches. We discuss the evidence on transaction costs and the price impact of trades and its analyses in terms of adverse selection, inventory costs and market power. We review the extent to which the associated frictions can be mitigated by such features of market design as the degree of transparency, the use of call auctions, the discreteness of the pricing grid and the regulation of competition between liquidity suppliers or exchanges.

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