What is it about?
We examine the extent to which order execution advantages affect price discovery for cross-listed stocks. We develop a measure of order executive advantage that captures qualities of trading costs, trading volume, market depth, and burdens to restore price parity of stock listings on the home exchange versus the NYSE. Our sample includes cross-listings from Canada, Brazil, and Mexico, three markets with nearly complete intraday overlap with the NYSE, yet with wide variability in order execution and price discovery qualities. We find that price discovery changes by 22% when order execution advantages reverse between the home exchange and the NYSE for cross-listed stocks. We also find that order execution quality strengthens for the home markets relative to the NYSE during the financial crisis in the latter part of 2008, leading to a migration of price discovery toward home markets during the crisis. During the financial crisis, the NYSE lost competitive advantages due to higher cost (i.e., wider bid-ask spreads and higher price impacts) combined with price pressure as the U.S. dollar appreciated forcing NYSE prices down to maintain price parity. The results are particularly strong for cross-listings from developed markets and for cross-listed stocks where the NYSE bears the lion’s share of adjusting to exchange rate fluctuations.
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Why is it important?
Prior studies examine home markets that dominate the order execution process, and, not surprisingly, find that home markets also dominate the price discovery process. We contribute to the literature by introducing a composite measure of order execution advantage capturing qualities of trading costs, trading volume, market depth, and exchange rate shocks, and by examining a diverse sample characterized by varying degrees of order execution advantages. Our measure of order execution extends beyond trading cost and trading volume variables used in most studies of price discovery. We show that both market depth and the burden to restore price parity significantly affect which exchange dominates price discovery for each cross-listing. By examining a sufficiently heterogeneous sample, our tests offer a more robust examination of the effects of order execution on price discovery. In contrast to previous studies, we find that the home market generally is not the price discovery leader. Rather, price discovery is evenly split between the home exchange and the NYSE after controlling for order execution advantages. In addition, our study highlights the effects of a financial crisis on price discovery.
Perspectives
Many studies conclude home markets dominate the price discovery process. One argument is home investors capture informational advantages, so price discovery is linked to the proximity of information to the country exchange, a trickle-down effect of information first to the home market, and then to the competing markets. On the other hand, price discovery may be affected by the quality of trade order execution. Therefore, inferences that home investors capture informational advantages may be a manifestation of order execution advantages achieved by the home market. We show that the quality of order execution is more likely to affect where institutions (informed traders) trade than where retail investors (noise traders) trade, and, therefore, likely affects where price discovery is established. By examining homogeneous samples with dominant home markets, previous studies are unable to disentangle effects on price discovery related to informational advantages versus order execution advantages. We address this void by introducing a measure of order execution and by examining stocks from multiple countries spanning a wide range of order execution advantage relative to the NYSE. We find that order execution advantages differ across markets and can change significantly over time. We find price discovery migrates toward the market offering better order execution quality (i.e., wider bid-ask spreads, lower trading volume, lower market depth, higher sensitivity to exchange rates) act as satellite markets, adjust to the more liquid market, and play a diminished informational role for prices.
Dr. Jimmy Lockwood
Southern Illinois University
Read the Original
This page is a summary of: PRICE DISCOVERY OF INTERNATIONALLY CROSS-LISTED STOCKS DURING THE 2008 FINANCIAL CRISIS, The Journal of Financial Research, July 2018, Wiley,
DOI: 10.1111/jfir.12151.
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