Market Microstructure and Information Economics

Ph D Course, Fall of 2002.

Updated Sept. 26, 2002


The course is expected to be taught in September-October of 2002. 


Course requirements:


·        The required reading assignment for each session consists of one journal article. Students are expected to have carefully read the article marked by a diamond (¨).

·        Each student should present 3 articles and do 3 referee presentations (a critique of an article presented by another student). The presentations should be deep enough to give the audience the understanding of (a) what is research question? (b) what is in the toolbox? (c)were the issues addressed? and (c) any tricks?

·        Prerequisites are Finance I and Finance II.

·        In order to obtain credit, you should do presentations/discussions (see above) and either do a term paper or small empirical project.

·        I hope that the project can lead to some research ideas that can be used in your thesis.

·        Most of the papers are available electronically either from HHS library web site or from If you cannot find some paper, please let me know.

·        I do not expect all the topics to be covered. However, the reading list will provide you with some starting points in your future reading if you desire to do it on your own.

·        I am not covering behavioral finance issues. I expect that you are familiar with them from Prof. De Bondt’ course.


¨ - Important paper (does not mean that the rest is not important!!!)


General references:


  1. ¨Madhavan, A., “Market Microstructure: A Survey,” Journal of Financial Markets, 3, August 2000, 205-258. – Latest review, a bit short but surprisingly complete.  
  2. ¨ Brunnenmeyer, Markus, "Asset pricing under asymmetric information" Oxford U. Press, 2001. - I think that this book is going to be the main textbook for this course. However, it is purely theoretical and does not have any institutional context.
  3. O’Hara, Maureen, “Market Microstructure Theory,” Blackwell Business, 1995. – The only decent book in market microstructure so far. Good for theory as of 95, short on empirical results.
  4. Grossman, “The Informational Role of Prices,” MIT press 1989.
  5. Jarrow et. al. Eds., Handbooks in OR & MS, Finance, Elsevier 1995. If you are planning to do research in finance, it is a good idea to buy this book anyway. Terribly expensive but worth the money.



Rational Expectations and Learning


  1. Grossman, S.  “An Introduction to the Theory of Rational Expectations under Asymmetric Information,” RES, 1981, 541-559
  2. Grossman, S.  “On the Efficiency of Competitive Stock Markets Where Traders Have Diverse Information,” JF, 1976,  573-585.
  3. ¨Grossman and Stiglitz: “On the Impossibility of Informationally Efficient markets,” AER 70, 393-408.
  4. ¨Grossman and Stiglitz: “Information and competitive price systems,” AER 66, 246-253.
  5. ¨Hellwig, “On the Aggregation of Information in Competitive Markets,” JET 477-498



Dynamic Rational Expectation Models I


  1. ¨Wang and He, 1993  “Differential information and dynamic behavior of stock trading volume”, RFS 919-972.
  2. ¨Wang (1993), “A model of intertemporal asset prices under asymmetric information,”  RES, 249-282.
  3. Wang (1994), “A Model of Competitive Trading Volume”, JPE,  127-168

4.      Hong and Wang (1995), “Trading and Returns Under Periodic Market Closures,” mimeo, MIT.

  1. Zhou (1998), “Dynamic portfolio choice and asset pricing with differential information” 1028-1051.
  2. Zhou (1999), “ Informational asymmetry and market imperfections: another solution to the equity premium puzzle”, JFQA, 445-464.
  3. Naik (1997), “On aggregation of information in competitive markets: the dynamic case”, JEDC, 1199-1227.
  4. Brennan and Xia (1998)  “Stock price volatility, learning and the equity premium”, Mimeo UCLA
  5. ¨Brennan (1998)  “ The role of learning in dynamic portfolio decisions”, Mimeo, UCLA
  6. ¨Balduzzi and Liu (2000) “Estimation risk, learning and international investment”, Mimeo.
  7. Campbell and Kyle (1993), “Smart money, noise trading and stock price behavior” RES.
  8. Veronesi (1999), “ Stock market overreaction to bad news in good times: a rational expectations equilibrium model”, 875-1007.
  9. ¨Veronesi (2000), “How does information quality affect stock returns?”, JF.
  10. Veronesi and David (2000), “Option prices with uncertain fundamentals”, Mimeo.
  11. Yan (2000), “Uncertain growth prospects, estimation risk and asset prices”, Mimeo.
  12. Barberis, (1999),  “Investing for the long run when returns are predictable”, Mimeo.



Models with Endogenous Information Acquisition


  1. Diamond and Verrecchia , “Information aggregation in a noisy rational expectations economy,” JFE, 221-235.
  2. Verrecchia, (1980),  “Consensus beliefs information acquisition and market information efficiency”, 874-883.
  3. Admati: “A noisy rational expectations equilibrium for multi-asset securities markets,” Econometrica, 629-657.
  4. ¨Admati and Pfleiderer, (1986), “A monopolistic market for information”, JET, 400-438.
  5. ¨Admati and Pfleiderer, (1987), “Viable allocations of information in financial markets”, JET, 76-115.
  6. ¨Admati and Pfleiderer,  “Markets for information”, JET, 96-103.
  7. ¨Admati and Pfleiderer, (1990), “Direct and indirect sale of information”, Econometrica, 901-928.
  8. Daniel, Hirshleifer and Subrahmanyam, (1994), “Security analysis and trading pattern when some investors receive information before others”, JF, 1665-1699.
  9. Hau, (1998), “Competitive Entry and Endogenous Risk in the Foreign Exchange Market”, RES, 11(4),  757-787


Inventory Models

  1. O’Hara: Chapter 2.
  2. ¨Amihud, Yakov and Haim Mendelson, “Dealership Market: Market Making with Inventory”, Journal of Financial Economics, 8, 1980, 31-53.
  3. ¨Ho, Thomas and Hans Stoll “The Dynamics of Dealer Markets Under Competition,” Journal of Finance, 38, September 1983, 1053-1074.
  4. ¨Hagerty, Kathleen “Equilibrium Bid-Ask Spreads in Markets with Multiple Assets,” Review of Economic Studies, 58, April 1991, 237-257.
  5. Spiegel, Matthew “Stock Price Volatility in a Mulitple Security Overlapping Generations Model,” Review of Financial Studies, 11, 1998, 419-447.
  6. ¨Ho, Thomas and Hans Stoll “Optimal Dealer Pricing Under Transactions and Return Uncertainty,” Journal of Financial Economics, 9, March 1981, 47-73.
  7. ¨Hansch, Oliver, Narayan Naik, and S. Viswanathan, “Do Inventories Matter in Dealership Markets? Some Evidence From the London Stock Exchange,” Journal of Finance, 53(5), October 1998, pages 1623-56.
  8. Gehrig, Thomas and Matthew Jackson “Bid-Ask Spreads with Indirect Competition Among Specialists,” Journal of Financial Markets, 1(1), April 1998, 89-120.



Kyle Model: Strategic Traders, Noise, and Risk Neutral Specialists

  1. ¨Kyle, Albert "Continuous Auctions and Insider Trading," Econometrica, 53, 1985, 1315-1335.
  2. Back, Kerry, Henry Cao, and Greg Willard, "Imperfect Competition among Informed Traders", Journal of Finance, October 2000, v. 55, iss. 5, pp. 2117-55
  3. ¨Foster, Douglas and S. Viswanathan "Strategic Trading When Agents Forecast the Forecasts of Others," Journal of Finance, 51(4), September 1996, 1437-78
  4. Spiegel, Matthew and A. Subrahmanyam “Informed Speculation and Hedging in a Noncompetitive Securities Market,” Reveiw of Financial Studies, 5, 1992, 307-329.
  5. Chowdhry, Bhagwan and Vikram Nanda "Multimarket Trading and Market Liquidity," Review of Financial Studies, 4, 1991, 483-511.
  6. ¨Foster, Douglas and S. Viswanathan “A Theory of the Intraday Variations in Volume, Variance, and Trading Costs in Securities Markets,” Review of Financial Studies, 3(4), 1990, 593-624.


Social Welfare and Market Performance with Insider Trading

  1. ¨Bhattacharya, Utpal and Matthew Spiegel “Insiders, Outsiders, and Market Breakdowns,” Review of Financial Studies, 4, 1991, 255-282.
  2. ¨Leland, Hayne “Insider Trading Should it be Prohibited?,”Journal of Political Economy, 100, August 1992, 859-887.
  3. Ausabel, Larry “Insider Trading in a Rational Expectations Economy,” American Economic Review, 80, 1990 1022-1041.
  4. ¨Glosten, Larry “Insider Trading, Liquidity, and the Role of the Monopolist Specialist,” Journal of Business, 62, April 1989, 211-235.
  5. Bhattacharay, Utpal, Phil Reny, and Matthew Spiegel "Destructive Interference in an Imperfectly Competitive Multi-Security Market," Journal of Economic Theory, February 1995, 136-170.
  6. Khanna, Naveen, Steve Slezak, and Michael Bradley “Insider Trading, Outside Search, and Resource Allocation: Why Firms and Society May Disagree on Insider Trading Restrictions,” Review of Financial Studies, Fall 1994, 575-608.
  7. ¨DeMarzo, Peter, Michael Fishman, and Kathleen Hagerty “The Optimal Enforcement of Insider Trading Regulations," Journal of Political Economy, 1998, 106, 602-632.



Bid-Ask Spread

  1. ¨Glosten, Larry and Paul Milgrom “Bid, Ask, and Transaction Prices in a Specialist Market with Heterogeneously Informed Traders,” Journal of Financial Economics, 14, March 1985, 71-100.
  2. ¨Affleck-Graves, John, Shantaram Hegde, and Robert Miller “Trading Mechanisms and the Components of the Bid-Ask Spread,” Journal of Finance, 49, September 1994, 1471-1488.
  3. ¨Georege, Thomas, Gautam Kaul, and M. Nimalendran, “Estimation of the Bid-Ask Spread and Its Components: A New Approach,” Review of Financial Studies, 4(4), 1991, 623-56.
  4. George, Thomas and Francis Longstaff “Bid-Ask Spreads and Trading Activity in the S&P 100 Index Options Market,” Journal of Financial and Quantitative Analysis, 28, September 1993, 381-397.
  5. Stoll, Hans "Inferring the Components of the Bid Ask Spread: Theory and Empirical Tests," Journal of Finance, 44, 1989, 115-134.
  6. ¨Hasbrouck, Joel "Measuring the Information Content of Stock Trades," Journal of Finance, 46, 1991, 179-207.
  7. Ball, Cliff and Tarun Chordia “True Spreads and Equilibrium Prices,” working paper Vanderbilt University, 1999.
  8. ¨Huang, R. and Hans Stoll “The Components of the Bid-ask Spread: A General Approach,” Review of Financial Studies, 10, 1997, 995-1034.
  9. Madhavan, Ananth and Seymour Smidt "An Analysis of Changes in Specialist Inventories and Quotations," Journal of Finance, 48(5), December 1993, 1595-1628.
  10. Jegadeesh, Narasimhan and Sheridan Titman “Short-Horizon Return Reversals and the Bid-Ask Spread,” Journal of Financial Intermediation, 4, April 1995, 116-133.
  11. Easley, David and Maureen O'Hara “Price, Trade Size, and Information in Securities Markets,” Journal of Financial Economics, 19(1), 1987, 69-90.
  12. ¨Easley, David and Maureen O'Hara “The Information Content of the Trading Process,” Journal of Empirical Finance, 4, June 1997, 159-186.
  13. Neal, Robert and Simon Wheatley “Adverse Selection and Bid-Ask Spreads: Evidence from Closed-End Funds,” Journal of Financial Markets, 1(1), April 1998, 121-149.



Market Microstructure and Asset Pricing

  1. ¨Brennan, Michael and Avidar Subrahmanyam, “Market Microstructure and asset pricing”, Journal of Financial Economics, 1996, 41, 441-464.
  2. ¨Easley, David, Soeren Hvidkjaer and Maureen O’Hara, “In Information Risk a Determinant of Asset Returns?” WP, 2000.
  3. Massa, Massimo, and A. Simonov ”Information Uncertainty and Stock Returns”, WP, 2001.


Information Disclosure

  1. ¨Fishman, Michael and Kathleen Hagerty “The Incentive to Sell Financial Market Information,” Journal of Financial Intermediation, 4, April 1995, 95-115.
  2. Fishman, Michael and Kathleen Hagerty “The Mandatory Disclosure of Trades and Market Liquidity,” Review of Financial Studies, 8, 1995, 637-676.
  3. Easley, David and Maureen O’Hara “Financial Analysis and Information Based Trade,” Journal of Financial Markets, 1(2), August 1998, 175-202.
  4. ¨Admati, A. and P. Pfleiderer “Forcing Firms to Talk: Financial Disclosure and Externalities,” Review of Financial Studies, 13, Fall 2000, 479-520.


Trading Mechanisms

  1. ¨Glosten, Larry “Is the Electronic Open Limit Order Book Inevitable?,” Journal of Finance, 49, September 1994, 1127-1161.
  2. ¨Madhavan, A. and V. Panchapagesan “Price Discovery in Auction Markets: A Look Inside the Black Box,” Review of Financial Studies, 13, Fall 2000, 627-658.
  3. Pirrong, C. “The Organization of Financial Exchange Markets: Theory and Evidence,” Journal of Financial Markets, 2, November 1999, 329-358.
  4. Chakravarty, Sugato and Craig Holden “An Integrated Model of Market and Limit Orders,” Journal of Financial Intermediation, 4, 1995, 213-241.
  5. ¨Dow, James and Gorton, Gary “Profitable Informed Trading in a Simple General Equilibrium Model of Asset Pricing,” Journal of Economic Theory, 67(2), December 1995, 327-69.
  6. ¨Ready, M. “The Specialist’s Discretion: Stopped Orders and Price Improvement,” Review of Financial Studies, 12, Winter 1999, 1075-1112.
  7. ¨Sofianos, G. and I. Werner “The Trades of NYSE Floor Brokers,” Journal of Financial Markets, 3, May 2000, 139-176.
  8. Kirilenko, A. “On the Endogeneity of Trading Arrangements,” Journal of Financial Markets, 3, August 2000, 287-314.


Market Manipulation

  1. Cherian, J. A. and R.A. Jarrow, "Market Manipulation", Chapter 20 of Handbook of Operations Research and Management Science, vol. 9, Finance, R. A. Jarrow, V. Maksimovic and V. T. Ziemba (editors), North- Holland, 1995.
  2. ¨Roland Benabou and  Guy Laroque, Using Privileged Information to Manipulate Markets: Insiders, Gurus, and Credibility, The Quarterly Journal of Economics, Vol. 107, No. 3. (Aug., 1992), pp. 921-958.
  3. Praveen Kumar and Duane J. Seppi, Futures Manipulation with "Cash Settlement", The Journal of Finance, Vol. 47, No. 4. (Sep., 1992), pp. 1485-1502.
  4. Mark Bagnoli, Barton L. Lipman, Stock Price Manipulation Through Takeover Bids, The RAND Journal of Economics, Vol. 27, No. 1. (Spring, 1996), pp. 124-147.
  5. ¨Franklin Allen and Douglas Gale, Stock-Price Manipulation, The Review of Financial Studies, Vol. 5, No. 3. (1992), pp. 503-529



Speculative Bubbles

  1. Brunnenmeyer, Markus, "Asset pricing under asymmetric information" Oxford U. Press, 2001, Chapter 6.
  2. Jean Tirole, On the Possibility of Speculation under Rational Expectations, Econometrica, Vol. 50, No. 5. (Sep., 1982), pp. 1163-1182.
  3. ¨Franklin Allen and Gary Gorton, Churning Bubbles, The Review of Economic Studies, Vol. 60, No. 4. (Oct., 1993), pp. 813-836.
  4. Allen, Morris and Postlewaite (1993) "Finite bubbles with Short Sales Constraint and Asymmetric Information", JET 61, pp. 206-229.
  5. ¨Dilip Abreu and Markus K.Brunnermeier, "Bubbles and Crashes"  Econometrica (forthcoming), WP 2001.

Herding Behavior

  1. Brunnenmeyer, Markus, "Asset pricing under asymmetric information" Oxford U. Press, 2001, Chapter 5.
  2. ¨Abhijit V. Banerjee, A Simple Model of Herd Behavior, The Quarterly Journal of Economics, Vol. 107, No. 3, Aug., 1992., pp. 797-817.
  3. ¨David S. Scharfstein and Jeremy C. Stein, Herd Behavior and Investment , The American Economic Review, Vol. 80, No. 3. (Jun., 1990), pp. 465-479.
  4. ¨Christopher Avery and Peter Zemsky, Multidimensional Uncertainty and Herd Behavior in Financial Markets, The American Economic Review, Vol. 88, No. 4. (Sep., 1998), pp. 724-748.
  5. Jeremy Bulow and Paul Klemperer, Rational Frenzies and Crashes, The Journal of Political Economy, Vol. 102, No. 1. (Feb., 1994), pp. 1-23.
  6.  Sushil Bikhchandani, David Hirshleifer, Ivo Welch, A Theory of Fads, Fashion, Custom, and Cultural Change as Informational Cascades, The Journal of Political Economy, Vol. 100, No. 5. (Oct., 1992), pp. 992-1026.
  7. Sushil Bikhchandani, David Hirshleifer, Ivo Welch. Informational Cascades and Rational Herding:
    An Annotated Bibliography and Resource Reference
    . It can be found on Ivo Welch' web site.

Lectures 2002: Schedule

Day Date Time Event Room
Mon September 2, 2002 17.15-19.00 Lecture 350
Wed September 4, 2002 15.15-17.00 Cancelled! 342
Mon September 9, 2002 17.15-19.00 Lecture 350
Wed September 11, 2002 15.15-17.00 Lecture 342
Mon September 16, 2002 17.15-19.00 Lecture 350
Wed September 18, 2002 15.15-17.00 Lecture 342
Mon September 23, 2002 17.15-19.00 Lecture 350
Wed September 25, 2002 15.15-17.00 Lecture 342
Mon September 30, 2002 17.15-19.00 Lecture 350
Wed October 2, 2002 15.15-17.00 Lecture 342
Mon October 7, 2002 17.15-19.00 Lecture 350
Wed October 9, 2002 15.15-17.00 Lecture 342
Mon October 14, 2002 17.15-19.00 Lecture 350
Wed October 16, 2002 15.15-17.00 Lecture 342

Room 342 and 350 is located on the 3th floor at the Stockholm School of Economics, Sveavägen 65.

Course Director

Assistant Professor Andrei Simonov
Department of Finance, Stockholm School of Economics
Room 677, Tel: 736 9159, e-mail  

Course Secretary

Marita Rosing
Department of Finance, Stockholm School of Economics
Room 665, Tel: 736 9140, e-mail