PRELIMINARY AND INCOMPLETE!
TRADING AND EXCHANGES: FIN 230
Professor Osler
Fall 2014
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Contact: cosler@brandeis.edu
Prof. Osler Office: Sachar 3rd floor
Telephone: Use e-mail
At bridge to Lemberg bldg
Teaching Assistant: Egill Agustsson
Prof. Osler Office Hours: By appointment
egillalmar@gmail.com
or drop by informally
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OVERVIEW
This course teaches students about the structure of trading in financial assets. The course
covers foreign exchange, equity, and bond markets world wide, but principles are most often
illustrated with respect to the foreign exchange market, the biggest financial market in the world.
Learning goals
 Market basics: Who trades, when do they trade, what do they trade? What regular patterns
are there in trading, bid-ask spreads, returns, and volatility?
 Market structures: Students learn the structure of dealership markets, limit-order markets,
call markets, two-tier markets. The types of orders available in each type of market and the
factors that drive order choice.
 Trading practice: Students simulate trading in dealership, OTC, and call markets, sometimes
trading against each other in class.
 The microeconomics of trading: How do dealers set bid-ask spreads? How does information
get into security prices, and how does this process vary according to market structure? What
is market liquidity, what drives liquidity, and who cares? What is “market transparency,” and
is it always a good thing? Why are there so many extremely large asset-price moves, even in
the absence of news surprises?
 Back office: What are “clearing” and “settlement”? What risks are associated with these and
how can those risks be managed? What is rogue trading, why do people become rogue
traders, and how can managers protect their firms from this problem?

Influence of microstructure on asset pricing: Students learn how asset returns are – or are
not -- influenced by market microstructure features such as liquidity, transparency, and
insider-trading rules. We discuss how trader reliance on stop-loss orders may contribute to
carry-trade profitability in currency markets.
The course usually includes at least one guest speaker.
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PRE-REQUISITES
Students must understand basic Statistics and how to think about regression results, basic
microeconomics, and basic finance (FIN 201 or the equivalent, usually called “Investments”).
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COURSE WORK
The course has a lecture forma complemented by homework assignments and by trading practice.
All students should keep in touch with the daily happenings in the financial world.
Grading:
Homework
Graded trading simulations
Market-design memo/presentation
Midterm
Final exam
20%
10%
15%
25%
30%
Homework Assignments



Distributed on Latte: due at the beginning of class.
NO LATE SUBMISSIONS. Answers will be posted on web shortly after class.
Write up your answers independently of others.
Trading Simulations

The FX Trading Game at oanda.com introduces students to dealership markets. This free FX
trading simulator assigns you a fictitious €100,000 and allows to you trade as if you are using
oanda.com’s trading platform. Students should submit listings of their trades and profits with
every problem set; there should be at least ten (10) trades per week (roughly 20 trades per
problem set).

The Virginia Econ Lab (VECONLAB) has a call market in which students can trade against
each other. We use this to learn about trading stocks in emerging market (call markets).

Nov. 12: Classroom continuous double-auction market. A continuous double-auction market
is essentially an in-person, voice version of an electronic limit-order market. We create one in
class.
Market Design Feature Memo or Presentation
Students will choose a specific, narrowly-defined market (e.g., the Bombay Stock Exchange) and
evaluate the suitability of a specific market design feature for that market. Interesting market design
features include

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

Circuit breakers
Anonymity
Opening and/or closing call markets
Smaller or larger tick sizes
Designated liquidity provider





Hidden orders
Short-sale constraints
Insider trading restrictions
Pre-trade transparency
Post-trade transparency
Final product: A memo of 3 pages or less (single spaced including references & citations). The memo
must provide

A thorough review of relevant institutional background information

An intelligent, informed synthesis of relevant academic research. (Relevant academic
research on many of these topics is listed at the end of the syllabus.)

A clear recommendation
Due dates




Tuesday, September 30: Initial group and topic choice submission to Professor Osler
Tuesday, October 7: Group and topic choice finalized
Tuesday, November 18: First drafts submitted
Tuesday, December 2: Final versions uploaded on Latte.
Midterm and Final Exams
Purpose: Help students with long-run retention of material.
All exams are cumulative and closed book
Midterm: October 21: Roughly 1 hour to answer plus 20 minutes to check your work.
Final exam is given at a time and place decided by the Registrar.
For both exams: You must be there. No exceptions except for verified medical emergency.
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Academic integrity is central to the mission of excellence at Brandeis.
Brandeis’ definition of Academic Integrity is here:
http://www.brandeis.edu/studentaffairs/srcs/forms/A%20Few%20Thoughts%20about%20Acade
mic%20Integrity1.pdf
For this class, remember:
 Complete all assigned work independently.
 You may not use the words of any other person on any assignment. Ideas from others
must be expressed in your own words, cited appropriately with a full reference. Citation
guidance is provided on Latte in the folder “Academic Integrity Resources.” Further details
of University standards can be found in Section Three of Rights and Responsibilities,
Violations of University policies on academic integrity may result in failure in the course or on
the assignment, or in suspension or dismissal from the University.
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Disability: If you are a student with a documented disability on record at Brandeis University and
want reasonable accommodation in this class, please see me at your earliest opportunity.
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CLASS DATES
August
September
October
November
December
T
Th
T
Th
M
T
Th
2
4
2
6
4
9
7
11
11
16
13 14
18
18
4
2
13
20
T
21
25
Th
28
23
23
T
28
Th
30
30
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READINGS
The course notes are your primary readings. Notes are available on Latte. Last year’s
notes are available from the beginning of the semester. BUT: they are typically revised both
before and after class.
Readings on equity markets are also assigned from a textbook: Lawrence Harris, Trading and
Exchanges (Oxford University Press 2003).
Additional readings are listed below. Some are required, some are not. Additional readings may
be assigned during the semester. If a URL is not provided, the document is probably up on
Latte. For most academic papers, master’s-level students read the introduction only while
Ph.D.s should read the whole papers.
Read strategically. Part of your education here concerns time management.
 To repeat: The course notes are your primary readings
 Big-picture content of all required articles may be tested on exams
 To study: Summarize the notes, chapters, or articles in writing with answers to these
questions:
o How is this article related to class material?
o What are the key lessons Professor Osler wants me to remember?
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COURSE OUTLINE AND READINGS
BACKGROUND, FINANCIAL MARKET STRUCTURES
Equities: Harris, Trading and Exchanges, Chapters 2 – 8, 24
FX: King, Osler, Rime, “Foreign Exchange Market Structure, Players, and Evolution,” Norges
Bank Working Paper 2011-10.
Fixed Income: Mizrach and Neely, The Microstructure of the U.S. Treasury Market, Sections 19 (pp. 2-18).
LIQUIDITY PROVISION AND BID-ASK SPREADS
Harris, Trading and Exchanges, Chapters 13-14, 19
Levich, “Why didn’t foreign exchange freeze up in the 2008 crisis? CLS Bank.” July, 2009.
(Latte)
Scandal!
Intro only: Christie, William, and Paul Schultz (1994), Why do NASDAQ market makers avoid
odd-eighth quotes? Journal of Finance 49, 1813–1840.
Intro only: Barclay, Christie, Harris, Kandel, Schultz (1999), “Effect of Market Reform on the
Trading Costs and Depth of NASDAQ Stocks.” Journal of Finance 54: 1-34.
Optional enrichment
Intro Only: Comerton-Forde, Carole, Hendershott, Jones, Moulton, Seasholes. Time
Variation in Liquidity: The Role of Market Maker Inventories and Revenues.
(Journal of Finance forthcoming).
Intro Only: Madhavan, Richardson, Roomans (1997). “Why Do Security Prices Change?
A Transaction-Level Analysis of NYSE Stocks,” Review of Financial Studies 10:
1035-1064.
Intro Only: Lin, Sanger, Booth, “Trade Size and Components of the Bid-Ask Spread,”
Review of Financial Studies, Vol. 8, No. 4 (Winter, 1995), pp. 1153-1183.
Intro Only: Hendershott, Menkveld. Price Pressures, 2011 Working Paper (Haas, UC
Berkeley).
Intro Only: Easley, Kiefer, O'Hara (1996). Cream skimming or profit sharing? The
curious role of purchased order flow, Journal of Finance 51: 811-833.
ORDER CHOICE
AND
PRICE DISCOVERY
Harris, Trading and Exchanges, Chapter 10
Intro Only: Menkhoff, Osler, Schmeling, “Limit-Order Submission Strategies under Asymmetric
Information.” Journal of Banking and Finance 34(11) (November 2010): 2665-2677.
Sections 4 & 5 only (pages 22, middle, through 30)! Osler, Mende, Menkhoff, “Price Discovery
in Currency Markets,” Journal of International Money and Finance 30 (8): 1696-1718. Page
proofs are on Latte.
Economist.com, “Marking the Dealer’s Cards,” Nov. 24, 2005.
Jen, Morgan Stanley Dollar Outlook, July 27, 2007: Monetary policy drives the effect of news.
For Ph.D.s only: Holden and Subrahmanyam, 1992.
REGULATION AND BACK OFFICE
Harris, Trading and Exchanges, Chapters 13-14.
McPartland, John, “Clearing and Settlement Demystified,” Chicago Fed Letter January 2005.
(Latte)
Miller: CLS Bank: Managing Foreign Exchange Settlement Risk. Bank of Canada Review
Autumn 2002. (Latte)
Indictment of Daiwa Bank (Latte)
Rogue Traders: Daiwa, Rusnak, SocGen Loss_01-08 (Latte)
LeBaton, Stephen, S.E.C. Chief Concedes Oversight Flaws Fueled Collapse
http://www.nytimes.com/2008/09/27/business/27sec.html?_r=1
Regulation and Reducing Risk: Finding the Right Balance. P. 10 in “Best Practice in Foreign
Exchange Markets 2010.” Euromoney. (Latte)
Selections from Deutsche Bank, Global Markets Research. “Emerging Markets Currency
Handbook 2011.”
MICROSTRUCTURE AND ASSET PRICING
Harris, Trading and Exchanges, Chapter 28.
Carry trade: Pages 20-30 only. Osler, “Market Microstructure and the Profitability of Currency
Trading,” on Latte.
Intro Only: Menkhoff, Sarno, Schmeling, Schrimpf (2009), “Carry Trades and Global FX
Volatility,” Munich Personal RePEc Archive.
Intro Only: MacDonald, R. “Expectations Formation and Risk in Three Financial Markets:
Surveying What the Surveys Say.” Journal of Economic Surveys, 14 (2000): 69-100.
Technical analysis: Section 5, Pages 33-38, only. Osler, “Market Microstructure and the
Profitability of Currency Trading,” on Latte.
Intro Only: Menkhoff and Taylor: “The Obstinate Passion of Foreign Exchange Professionals:
Technical Analysis”
Intro Only: Easley, Hvidkjaer, O'Hara (2002). Is information risk a determinant of asset
returns? Journal of Finance 57: 2185-2221.
Optional enrichment
Intro Only: Amihud, Y., H. Mendelson and L. H. Pedersen (2006). Liquidity and asset
prices. Foundations and Trends in Finance 1(4): 269-URL:
http://pages.stern.nyu.edu/~lpederse/papers/LiquidityAssetPricing.pdf
Intro Only: Chordia, Roll, Subrahmanyam (2000), Commonality in Liquidity, Journal of
Financial Economics 56: 3-28.
Intro Only: Vayanos, D. and J. Wang (2009). Liquidity and Asset Prices: A Unified
Framework. http://ssrn.com/paper=1440172.
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SUGGESTED READINGS FOR CERTAIN MARKET DESIGN TOPICS
Harris, Trading and Exchanges, Chapter 9
Designated Liquidity Provider?
Mann, Venkataraman, & Waisburd (2003). Stock Liquidity and the Value of a
Designated Liquidity Provider: Evidence from Euronext Paris. WP Texas Christian
University. http://www.cabafx.com/trading-ebookscollection/Mann,%20Venkataraman%20And%20WaisburdStock%20Liquidity%20And%20The%20Value%20Of%20A%20Designated%20Liq
uidity%20Provider%20Evidence%20From%20Paris%20Euronext.pdf
Nimalendran & Petrella (2003). Do “Thinly-Traded” Stocks Benefit from Specialist
Intervention? Journal of Banking and Finance 27 (2003) 1823–1854.
Anand, Amber; Weaver, Daniel G. (2006). The Value of the Specialist: Empirical
Evidence from the CBOE. Journal of Financial Markets vol. 9(2): 100-118.
Anand, Amber; Tanggaard, Carsten, and Weaver, Daniel G. (2009). Paying for Market
Quality. Journal of Financial and Quantitative Analysis 44(December): 1427-1457.
Market Fragmentation
Harris, Trading and Exchanges, Chapter 26.
Intro only: O'Hara and Ye, “Is Market Fragmentation Harming Market Quality?” Journal
of Financial Economics, 2011 100 (3): 459-74.
Intro only: Market Fragmentation: Foucault and Menkveld, “Competition for Order Flow
and Smart Order Routing Systems,” Journal of Finance, February 2008 63 (1): 119158.
Transparency
Intro only: Madhavan, Porter, and Weaver, “Should Securities Markets be Transparent?”
Journal of Financial Markets 8 (2005): 266-277. ONLY through Section 4.2.
Intro only: Boehmer, Saar, Yu, “Lifting the Veil: An Analysis of Pre-trade Transparency
at the NYSE,” Journal of Finance 60 (2): 783-815.
Intro only: Grossman, Sanford, and Merton Miller (1988). Liquidity Provision and
Market Structure. Journal of Finance 43: 617-633.
Insider Trading
Harris, Trading and Exchanges, Chapter 29.
Lewis, Michael, “Jonathan Lebed: Stock Manipulator, S.E.C. Nemesis  and 15,” New
York Times February 25, 2001.
http://www.nytimes.com/2001/02/25/magazine/25STOCK-TRADER.html?pagewanted=all
Intro only: Bhattacharya, Daouk, Jorgenson, Kehr (2000). “When an Event is Not an
Event: The Curious Case of an Emerging Market.” Working paper version, ultimately
published in Journal of Financial Economics.
Intro only: Bhattacharya & Daouk (2002), “World Price of Insider Trading,” Journal of
Finance 57 (1): 75-108.
Intro only: Bhattacharya, Daouk (2004). “When No Law is Better Than a Good Law.”
CEI Working Paper Series 2004-10.
Intro only: King, Michael. “Prebid Run-Ups Ahead of Canadian Takeovers: How Big is
the Problem?” Financial Management Winter 2009: 699-726.
Hidden Orders
Intro only: De Winne and D.Hondt (2007), Hide-and-Seek in the Market: Placing and
Detecting Hidden Orders, Review of Finance 11, 663-692.
Intro only: Hasbrouck and Saar (2009), Technology and Liquidity Provision: The
Blurring of Traditional Definitions, Journal of Financial Markets, 12, 143-172.
Intro only: Bessembinder, Panayides, and Venkataraman, 2009, Hidden Liquidity: An
Analysis of Order Exposure Strategies in Electronic Stock Markets, Journal of
Financial Economics 94, 361-383.
Intro only: Aitken, Berkman, Mak (2001), The use of undisclosed limit orders on the
Australian Stock Exchange, Journal of Banking and Finance 25, 1589-1603.
Intro only: Harris (1997), Order Exposure and Parasitic Traders, University of Southern
California Working Paper.
Intro only: Anand and Weaver (2002), Can order exposure be mandated? Journal of
Financial Markets, 7, 405-426.
Intro only: Belter (2007), Supply and Information Content of Order Book Depth: The
case of displayed and hidden depth, Aarhus School of Business, Working Paper.
Circuit Breakers
Harris, Trading and Exchanges, Chapter 28
Intro only: Ackert, Church, and Jayaraman (2001), “An Experimental Study of Circuit
Breakers: The Effect of Mandated Market Closures and Temporary Halts on Marekt
Behavior,” Journal of Financial Markets 4: 185-208.
Intro only: Corwin and Lipson (2000), “Order Flow and Liquidity Around NYSE Trading
Halts,” Journal of Finance 55: 1771-1801.
Intro only: Goldstein and Kavajecz (2005), “Trading Strategies During Circuit Breakers
and Extreme Market Movements,” Journal of Financial Markets 7: 301-333.
Short-sales Constraints
Intro only: Short-sales constraints: Harris, Namvar, Phillips (2009). Price inflation and
wealth transfer during the 2008 SEC short-sale ban.
http://www.nber.org/confer/2009/mms09/namvar.pdf.
Intro and lit review only: Short-sales constraints: Boehmer, Jones, Zhang (2009).
Shackling Short Sellers: The 2008 Shorting Ban. http://ssrn.com/paper=1412844.
Jain, Jain, McInish (2013), Worldwide Reach of Short Selling Regulations, Journal of
Financial Economics July 2013 (109): 177-97.
Beber & Pagano, Short-Selling Bans Around the World: Evidence from the 2007-2009
Crisis, Journal of Finance 68(1) February 2013: 343-381.
Tick Size
Intro Only: Chakravarty, Harris, Wood (2001), “Decimal Trading and Market Impact,”
Working Paper. http://www2.owen.vanderbilt.edu/fmrc/Activity/paper/DecimalsVer2.1.pdf
Intro only: Goldstein and Kavajecz, "Eighths, Sixteenths, and Market Depth: Changes in
Tick Size and Liquidity Provision on the NYSE" Journal of Financial Economics,
April 2000, Vol. 56: 125-149.
Tavy Ronen, Daniel G Weaver (2001). “Tennies” Anyone? Journal of Financial Markets,
4(3): 231-260
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