Stock markets Marco Pagano and Ailsa Roell The deregulation of financial markets and the liberalization of international capital flows raises a number of challenging issues. Market participants and policy-makers are treading largely uncharted territories. This article offers some markers, exploring the implications of economic principles and producing new evidence on European stock exchanges. One vast set of issues concerns the design of market operations. The article compares the merits, both in theory and in practice, of auctions versus market-making, of concentration versus fragmentation of trading, of batch auctions versus continuous markets and of single- versus dual-capacity dealers. Policy conclusions are grounded on a detailed analysis of the experience accumulated on European and North American exchanges. Another theme runs through this article: the implications for the relative competitiveness of European financial markets. Rapid changes have already occurred in the late 1980s: while much wholesale trade has moved to London, continental exchanges have grown at an accelerated pace. We examine whether this is connected to innovations in trading systems and regulation. The paper also attempts to foresee the geographical structure of Europe's integrated stock markets. At stake is the hierarchy of financial centres, the potentially dangerous drift towards competitive deregulation and the scope for wholly computerized trading where market location becomes irrelevant.
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