Momentum Profits in Alternative Stock Market Structures

Abstract

The aim of this study is to examine the relationship between momentum profitability and the stock market trading mechanism and is motivated by recent changes to the trading systems that have taken place on the London Stock Exchange. Since 1975 the London stock market has employed three different trading systems: a floor based system, a computerised dealer system called SEAQ and the automated auction system SETS. The level of transparency and operational efficiency that each system provides exerts an important influence on the diffusion of information. Since behavioural finance argues that the diffusion rate of information exerts a major influence over momentum we examine whether the magnitude of momentum profits are related to the type of stock market trading system. We find that after the introduction of the computerised dealer system SEAQ momentum profits are higher than when the floor based system operated. We also find that companies trading on the SETS auction system display greater momentum profitability than shares trading on SEAQ. Our results are robust to the use of different samples and alternative risk adjustments.

Keywords: Momentum effect, Big Bang, Stock Exchange Automated Quotation System (SEAQ), Stock Exchange Electronic Trading System (SETS)

JEL Classification: G12, G14