1. Upending Stock Market Structure Using MPC CHARANJIT S. JUTLA IBM RESEARCH

2. Talk Outline What exactly is the purpose of the stock market? Is there a problem with the stock market? Demand and Supply (Eco-101) Modeling (Private) Information in Equilibrium Pricing Price Discovery Mechanisms Novel (or antiquated) Structure of Stock Market Illustrative Analysis

3. Stock Market Purpose Price Discovery ◦Important for investment decisions ◦Effectively centralizes distributed information Liquidity – it is a market! NYSE vs NASDAQ (Double Auctions) Is there a problem? ◦What’s with all the day traders and HFT? Liquidity? ◦Trusting the Specialist to hide your bids? ◦Let’s Model

5. Walrasian Equilibrium (1877)

6. Walrasian Equilibrium

7. Grossman-Stiglitz Critique (1980) Impossibility of Informationally efficient markets ◦Efficient Markets Hypothesis – Prices reflect all the information ◦Even “Informed” Traders “Private” Information? ◦Then informed traders have no incentive. ◦So, in “equilibrium” no one is doing any research! ◦But, that is not an equilibrium! ◦CONCLUSION: Prices do not reflect all the information.

8. Easley-O’Hara Model (2004)

9. price Cumulative Demand and Supply BUY SELL Market price buy Market price sell CLEARING PRICE DOUBLE AUCTION (CPDA)

10. price Cumulative Demand and Supply

11. price Cumulative Demand and Supply s

12. Upshot If there is no private signal, or “signal” is public knowledge: ◦converges to Walrasian equilibrium. ◦incentivizes “uninformed”. Private Information is clearly not revealed till auction is over. ◦Informed are further incentivized. ◦Uninformed continue to get a return (so liquidity providers remain). ◦If everyone does research, faster equilibrium pricing!

13. Open Questions? ◦Mostly Finance Questions. ◦But, Additional Leakage - Performance Tradeoffs. ◦Treating Buyers and Sellers symmetrically in analysis. ◦Volume reveals signal after auction is over in simple model. ◦Periodic CPDA.

14. THANKS!