Market Structure and Liquidity on the Tokyo Stock Exchange

Most equity market mechanisms have designated market makers who provide continuous liquidity. This is not the case on one of the largest and most active stock markets in the world: the Tokyo Stock Exchange (TSE). Its designated intermediaries are merely order clerks called saitori, who log limit orders in a public limit order book and match incoming market orders against them in accordance with strict rules based on price, time, and size priority. On the TSE, orders from the investor public, not from designated market makers, bridge temporal fluctuations in the demand for liquidity. In this paper, we study the chui and tokubetsu kehai (warning and special quote) mechanisms of the TSE. Since no designated market ;maker stands ready to absorb transient order flow variation, these procedures provide for flagging possibly transient order imbalances and for routinely halting trade to attract orders when particular kinds of order imbalances occur. Such mechanisms always trade the benefits of attracting more liquidity to the marketplace against the cost of impeding the price discovery process and the immediacy of execution. We establish several facts about the impact of these mechanisms on market liquidity. Investors seldom trip the trading halt mechanisms of the TSE and, when they do, they usually execute all or part of their order at the warning quote, a price known in advance. Traders are more likely to trigger indicative quote dissemination and temporary trading halts when the market is relatively volatile, particularly around the morning open and after delayed opens. The volume of trade is similar when orders do and do not result in trading halts, an economically sensible result since the ex ante limit order books should be identical. Substantially larger trades and special quote trading halts (which provide for price discovery through orderly quote changes), a result that is also intuitively plausible. What is perhaps surprising is not that these result accord with intuition but rather that they conform to it so well.