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Microstructure and asset pricing

In: Handbook of the Economics of Finance

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  • Easley, David
  • O'Hara, Maureen

Abstract

Market microstructure and asset pricing both consider the behavior and formation of prices in asset markets. Yet neither literature explicitly recognizes the importance and role of the factors so crucial to the other approach. This survey seeks to join the two literatures by surveying the work linking microstructure factors to asset price dynamics. In the short run, these dynamics involve issues such as the auto-correlation and cross-correlation structure of stocks, and our survey will examine the literature relating these correlation structures to microstructure factors such as non-synchronous trading and dealer behavior. In the longer run, issues such as liquidity and the relation of private information to asset price dynamics are important. We survey the theoretical work linking microstructure factors to long-run returns, and we consider why stock prices might be expected to reflect premia related to liquidity or informational asymmetries. We also survey the empirical literature testing these relationships. We then discuss what issues remain contentious, and we provide some guidance for future research. We hope to show in this survey that asset-pricing dynamics may be better understood by recognizing the role played by microstructure factors, and that microstructure research can be enhanced by a greater understanding of its linkages with fundamental economic variables.

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This chapter was published in:

  • G.M. Constantinides & M. Harris & R. M. Stulz (ed.), 2003. "Handbook of the Economics of Finance," Handbook of the Economics of Finance, Elsevier, edition 1, volume 1, number 2, March.
    This item is provided by Elsevier in its series Handbook of the Economics of Finance with number 2-17.

    Handle: RePEc:eee:finchp:2-17

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    Web page: http://www.elsevier.com/wps/find/bookseriesdescription.cws_home/BS_HE/description

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    Cited by:
    1. Loderer, Claudio & Roth, Lukas, 2005. "The pricing discount for limited liquidity: evidence from SWX Swiss Exchange and the Nasdaq," Journal of Empirical Finance, Elsevier, vol. 12(2), pages 239-268, March.
    2. Gregory H. Bauer & Clara Vega, 2006. "The monetary origins of asymmetric information in international equity markets," International Finance Discussion Papers 872, Board of Governors of the Federal Reserve System (U.S.).
    3. James Dow & Gary Gorton, 2006. "Noise Traders," NBER Working Papers 12256, National Bureau of Economic Research, Inc.

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