Changing the Rules of the Game : A Market Microstructure Perspective on the Effects of Regulating Financial Markets

Abstract: This dissertation contains four articles that examine the effects brought about by the implementation of new regulations and changes in the trading landscape on different facets of market quality and integrity.Article I studies how the fragmentation of equity markets affects the speed of recovery of the market, both under normal market conditions and in times of stress. The results show that fragmentation increases the average ability of the market to converge towards its long-run liquidity levels by shortening the duration of liquidity deviations. In times of stress, fragmentation also speeds up the replenishment of the limit order book and its ability to recover from the moments of stress.Article II examines the impact of introducing short selling restrictions on the speed of recovery of the market and commonality in liquidity. The findings indicate that short selling bans contribute to lowering the risk of financial contagion by decreasing the commonality in liquidity levels of banned securities. However, the restrictions also significantly hamper the ability of banned stocks to recover from transitory liquidity deviations.Article III exploits the change in closing mechanism of 43 exchanges around the world to analyse the effects of batch facilities on liquidity, price efficiency, and market integrity. The results support the idea that batch facilities improve market quality, that auction design is important in explaining auction performance, and that the effects depend on the level of development of the market and the liquidity of the stock.Article IV investigates whether volatility extensions in closing auctions improve the efficiency of closing prices. The findings confirm that the introduction of a volatility extension enhances price efficiency by reducing transitory closing price volatility. The results also suggest that the improvement in price efficiency is due to enhanced market integrity and to greater investor trust in the auction mechanism.