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Academic Research - April 25, 2012

Markets today bear essentially no resemblance to markets just ten years ago - an interview with Ekkehart Boehmer

In this month's interview, Ekkehart Boehmer, Professor of Finance at EDHEC Business School, discusses his research on execution and trading on equity markets, with a particular focus on high-frequency trading. He also talks about his research on short selling and the effectiveness of short selling bans. Before joining academia, Ekkehart Boehmer was Director of Research at the New York Stock Exchange and Senior Economist at the U.S. Securities and Exchange Commission.

Ekkehart Boehmer

You recently conducted an executive seminar in Singapore entitled “Execution and Trading on Equity Markets – The New Landscape?” Could you tell us in a few words what this new landscape consists of?

Ekkehart Boehmer: Until about five years ago, equity trading was dominated by a few leading exchanges, such as the NYSE and Nasdaq in the U.S. and perhaps the London Stock Exchange and Euronext in Europe. With increasing demand for fast-trading infrastructure, regulators on both sides of the Atlantic created a playing field that pushed “slow” markets to the sidelines and allowed new entrants to compete effectively with the incumbent markets.

Today, no trading venue in the U.S. or in Europe has more than 25% market share and virtually all trading is done in “fast” markets. These developments have attracted substantial amounts of additional trading volume and enormous order-related message traffic that regulators and some market participants are now struggling to cope with.

Part of your course in Singapore, and indeed a separate seminar, was devoted to understanding high-frequency trading and its impact on markets. Could you share some of the results of your research into high-frequency trading with us?

Ekkehart Boehmer: We use intraday data on about 13,000 stocks from 39 countries to compare periods and stocks with high message traffic to those with low message traffic. High message traffic, a measure based on the number of quote changes and trades, indicate high levels of algorithmic-trading activity.

On the up side, we find that greater AT intensity is, on average, associated with more liquidity and faster price discovery. On the down side, algorithmic trading causes greater volatility.

We also show that the liquidity-enhancing effect takes place only in larger firms – the smallest third of stocks experiences declines in liquidity when algo traders are more active. All these results are remarkably consistent across different markets.

Your research on short selling has been highlighted in recent times due to the numerous short selling bans that were imposed during the financial crisis. Could you summarise the results of that line of your research for us?

Ekkehart Boehmer: We show that short sellers tend to be informed traders, in the sense that a portfolio that is long in the least shorted decile of stocks and short in the most shorted decile will earn substantial risk-adjusted returns. We estimate this return to be around 15-20% on an annualized basis. We show that a substantial portion of this information is related to fundamentals.

Overall, empirical work by us and others tends to show that short sellers makes prices more accurate and also provide significant liquidity to other traders. This became especially obvious during the 2008 ban on shorting in the U.S. We show that when regulators forced short sellers out of the market, trading costs in the affected stocks multiplied by a factor of 2-3. This suggests that market participants other than short sellers actually bear a substantial portion, if not most, of the costs imposed by shorting bans.

Could you tell us about any of your other current or future research projects whose results may prove to be useful for professionals?

Ekkehart Boehmer: We are continuing to improve our existing work on algo trading and high frequency trading and we are beginning to design several new projects in this area.

Before working full-time in academia, you were Director of Research at the New York Stock Exchange. Has that professional experience had an impact on your academic work?

Ekkehart Boehmer: It had an enormous impact on my work. On one hand, it is quite difficult to do meaningful research in financial economics without understanding the institutional details of equity markets and without understanding recent developments. This is especially true in my area, market microstructure, where markets today bear essentially no resemblance to markets just ten years ago.

About Ekkehart Boehmer

A specialist in equity market micro-structure and the economics of trading, Ekkehart Boehmer joined EDHEC Business School as Professor of Finance in 2011. He was previously the John B. Rogers Professor of Banking and Finance at the University of Oregon Lundquist College of Business, and prior to that, the holder of the Nichols Professorship of Finance at Texas A&M University Mays Business School.

He has also held positions in the financial industry, as Director of Research at the New York Stock Exchange and Senior Economist at the U.S. Securities and Exchange Commission.

His research focuses on equity markets with emphasis on micro-structure, short-selling, market efficiency, and initial public offerings. He has also researched corporate governance and mergers and acquisitions.

He has published in leading journals, including the Journal of Finance, Journal of Financial and Quantitative Analysis, Journal of Financial Economics, Journal of Financial Intermediation, and the Review of Financial Studies. He serves as associate editor to Financial Management and the Review of Financial Studies.