Market Microstructure : A Proxy for Assessing Policy-Making, Regulation, and Market Movement on a Spectrum of Scales

Abstract

Behind the scenes of how a market price is determined, there is a lot going on in the background with how the sell side packages and distributes liquidity to the clients on the buy side. Market prices are believed to exist in two states: efficient and inefficient. It is said that price movements spend roughly 80% of the time in range bound conditions. For instance, if the bid/ask spread is adjusted ever so slightly, this can cause price to “slip” and move inefficiently. It is important to understand the two different states, especially when the market is in rhythmic states of dealing, and to observe the way inefficient moves are reflected on a chart. Studying market microstructure should provide more insight into what is going on in the background of price movements and why price moves the way it does. I’m particularly interested in how the algorithms collectively compound a price movement, when considering the plethora of independent liquidity providers that exist. While current research might not fully explain this idea, studying market microstructure should provide a framework for what’s occurring in the background.