Essays on Market Microstructure

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This dissertation consists of two essays on financial market microstructure. The first essay Information Acquisition and Short Selling, co-authored with Dr. Kevin Roshak, investigates the effects of suspending the short selling uptick rule on the price discovery process. Sophisticated traders, such as short sellers, may deter information acquisition by less sophisticated traders. We measure information acquisition as the contribution of earnings announcements to volatility—when earnings announcements account for a greater share of volatility, then less of the information is priced prior to announcements. We use the SEC’s short sale pilot program and find that information acquisition falls when short selling is easier and the effect reverses after the pilot. We find symmetric results for good and bad news, consistent with information acquisition as opposed to a direct effect of short-selling activity. Further, we study the mechanism by combining the pilot program with the discontinuity in institutional ownership around the Russell 1000/2000 threshold. Pilot (but not control) stocks suffer particularly large losses in information acquisition where institutional ownership increases around the threshold, consistent with complementarity between lendable shares and easier short selling rules. Our results suggest that short sellers, while informed themselves, can decrease price efficiency by deterring the information acquisition of others. In the second essay, I examine the SEC's 2016 pilot program that increases the tick size from 1 cent to 5 cents for over 1,000 illiquid stocks. I use the market makers' daily participation to directly measure the effect of this tick size increment on liquidity provision. The results show that increases in information and inventory costs and reduction in trading share volume cannot justify the rise in bid-ask spread---the wider tick size incentivizes market-making. Additionally, I find that liquidity traders leave the large-tick stocks and migrate to the small-tick stocks, which is consistent with negative spillover effects. Overall, the evidence suggests that the tick size increase profits the market makers at the expense of liquidity demanders.

Market Microstructure, Short Selling, Tick Size