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 andoperations, is now a strategic resource used in attracting or retaining market liquidity.Established exchanges introduce technology to enhance their markets. New marketvenues challenge the status quo and rely on technology to offer diverse services toincreasingly sophisticated investors. In this paper, we examine the strategic designdecisions embedded in these new electronic trading systems. Design decisions arecritical, as they determine the market microstructure which influences investingstrategies, patterns of trade, liquidity and volatility. We propose a taxonomy of designalternatives based on six major dimensions: market structure, type of orders, orderexecution priority rules, price discovery rules, time stamping, and transparency. Usingexamples of existing systems, we discuss the potential impact of the various alternativeson the eventual attractiveness of the market to the investors.