Electronic Trading Systems: Strategic Implications of Market Design Choices

Abstract

Modern financial markets compete aggressively for trading activity and investor interest. Information technology, once a crucial element in streamlining paper flows and operations, is now a strategic resource used in attracting or retaining market liquidity. Established exchanges introduce technology to enhance their markets. New market venues challenge the status quo and rely on technology to offer diverse services to increasingly sophisticated investors. In this article, we examine the strategic design decisions embedded in these new electronic trading systems. Design decisions are critical, as they determine the market microstructure that influences investing strategies, patterns of trade, liquidity, and volatility. We propose a taxonomy of design alternatives based on 6 major dimensions: market structure, type of orders, order execution priority rules, price discovery rules, time stamping, and transparency. Using examples of existing systems, we discuss the potential impact of the various alternatives on the eventual attractiveness of the market to the investors.