Equity Markets, Trading and Data

Abhay Abhyankar
University of Exeter, U.K.

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Road Map

Financial markets & Trading, Data sources etc.

Asset Pricing: Consumption-based & Linear Factor Models.

Asset Pricing: Empirical Test Strategies.

Efficient Markets & Event Studies.

Present Value Models & Return Predictability.

Student Presentations.
Today
• Big Picture on Equity Markets- with a U.S. focus- of course,
there are other equally important markets for bonds,
derivatives and commodities and markets in other countries
etc. but for now…..
• Types of markets, Stock Offerings, Regulations, Trading
Structures- role of financial intermediaries like brokers and
dealers.
• Trading: More details about trading, bid-ask spreads, margin
trading, short selling etc.
• Data and other issues in empirical work.
Equity Markets: The Big Picture
Types of Financial Markets

• Money Markets: the market where short-term securities are

bought and sold

• Capital Market: the market where long-term securities such as

stocks and bonds are bought
and sold

• Primary Market: the market in which new issues of securities

are sold to the public

• Secondary Market: the market in which securities are traded

after they have been issued
 Primary Markets
• Initial Public Offering (IPO)
– First public sale of a company’s stock
– Requires SEC approval

• Three Choices to Market Securities in Primary Market

– Public offering: an offering to sell to the investing public a set number of
shares of a firm’s stock at a specified price

– Rights offering: an offering of a new issue of stock to existing stockholders,

who may purchase new shares in proportion to their current ownership

– Private Placement: an offering of a company's securities that is not

registered with the Securities and Exchange Commission (SEC) and is not
offered to the public at large.
Going Public: The IPO Process
• Underwriting the offering: promoting the stock and
facilitating the sale of the company’s shares

• Prospectus: registration statement describing the issue and the

issuer

• Red Herring: preliminary prospectus available during the

waiting period

• Quiet Period: time period after prospectus is filed when

company must restrict what is said about the company

• Road Show: series of presentations to potential investors

 The Investment Banker’s Role
• Underwriting the Issue: purchases the security at agreed-on price
and bears the risk of reselling it to the public
• Underwriting Syndicate: group formed by investment banker to
share the financial risk of underwriting
• Selling Group: other brokerage firms that help the underwriting
syndicate sell issue to the public
• Tombstone: public announcement of issue and role of participants in
underwriting process
• Investment Banker Compensation: typically in the form of a
discount on the sale price of the securities
Selling Process for a Large Security Issue
Typical Preliminary Prospectus for a Stock Issue
Secondary Markets
• Secondary Market: the market in which securities are traded
after they have been issued
Role of Secondary Markets
– Provides liquidity to security purchasers
– Provides continuous pricing mechanism

• Securities Exchanges: forums where buyers and sellers of

securities are brought together to execute trades
• Nasdaq Market: uses an electronic trading platform to execute
trades; NYSE has a specialist system.
• Over-the-counter (OTC) Market: involves trading in smaller,
unlisted securities
Broker Markets and Dealer Markets
• Broker Markets: consists of national + regional securities exchanges
– 60% of the total dollar volume of all shares in U.S. stock market
trade here.
– New York Stock Exchange (NYSE) is largest and most well-known.
– Trades executed when a buyer and a seller are brought together by
a broker and the trade takes place directly between the buyer and
seller
• Dealer Markets: consists of Nasdaq OMX market & the OTC market
– Trades are executed with a dealer (market maker) in the middle.
Sellers sell to a market maker at a stated price. The market maker
then offers the securities to a buyer.
• A broker executes the trade on behalf of others, a dealer trades on
their own behalf.
Figure 2.3 Broker and Dealer Markets
Broker Markets
• New York Stock Exchange (NYSE)
– Largest stock exchange, Specialists make transactions in key stocks
– Strictest listing policies
• NYSE Amex (formally American Stock Exchange)
– Major market for Exchange Traded Funds
– Typically smaller and younger companies who cannot meet stricter
listing requirements for NYSE
• Regional Stock Exchanges
– Listing requirements are more lenient than NYSE
– Often include stocks that are also listed on NYSE or NYSE Amex
– Best-known: Midwest, Pacific, Philadelphia, Boston, and Cincinnati
• Options Exchanges
– Best-known: Chicago Board Options Exchange (CBOE)
• Futures Exchanges
– Best-known: Chicago Board of Trade (CBT)
Dealer Markets
• No centralized trading floor; comprised of market makers linked by
telecommunications.
• NASDAQ
– Largest dealer market; Lists large companies (Microsoft, Intel,
Dell, eBay) & smaller companies
• Over-the-counter (OTC) Bulletin Board
– Lists smaller companies that cannot or don’t wish to be listed on
Nasdaq
– Companies are regulated by SEC
• Over-the-counter (OTC) Pink Sheets
– Lists smaller companies that are not regulated by SEC
– Liquidity is minimal or almost non-existent
– Very risky; penny stocks.
Alternative Trading Systems
• Third Market
– Institutional investors (mutual funds, life insurance companies,
pension funds) go through market makers that are not members
of a securities exchange.
– receive reduced trading costs due to large size
of transactions

• Fourth Market
– Institutional investors deal directly with each other to bypass
market makers
– Electronic Communications Networks (ECNs) allow direct trading
– ECNs most effective for high-volume, actively traded securities
Regulation of Securities Markets
• Securities Act, 1934- Established SEC as government regulatory body
• Maloney Act, 1938-Allowed self-regulation of securities industry
through trade associations such as the National Association of
Securities Dealers (NASD)
• Investment Company Act, 1940- Regulates mutual funds
• Investment Advisors Act of 1940- Requires investment advisers to
make full disclosure about their backgrounds and their investments,
as well as register with the SEC
• Securities Acts Amendments of 1975- Abolished fixed-commissions
and established an electronic communications network to make stock
pricing more competitive
• Insider Trading and Fraud Act of 1988- Prohibited insider trading on
nonpublic information
• Sarbanes-Oxley Act of 2002-Tightened accounting and audit
guidelines to reduce corporate fraud
Current Research Issues: Why have number of listed
firms in the U.S. declined?

From: "Eclipse of the Public Corporation or Eclipse of the Public Markets?"

by Craig Doidge, Kathleen M. Kahle, G. Andrew Karolyi, and René M. Stulz,
Rise in Intangible Capital

From: "Eclipse of the Public Corporation or Eclipse of the Public Markets?"

by Craig Doidge, Kathleen M. Kahle, G. Andrew Karolyi, and René M. Stulz,
Rise in Institutional Ownership and Ownership
concentration in S&P 500 firms at national level-1 (U.S.A)

From: Backus, Conlon, Sinkinson, 2019,The Common Ownership Hypothesis: Theory and
Evidence, Brookings Institute
Excellent write up on how to get data from SEC filings +data
https://sites.google.com/view/msinkinson/research/common-ownership-data
Rise in Institutional Ownership and Ownership
concentration in S&P 500 firms at national level-1 (U.S.A)

From: Backus, Conlon, Sinkinson, 2019,The Common Ownership Hypothesis: Theory and
Evidence, Brookings Institute
Excellent write up on how to get data from SEC filings +data
https://sites.google.com/view/msinkinson/research/common-ownership-data
 Rise in Institutional and Ownership concentration in
geographically? – may be not

From: Diverging Trends in National and Local Concentration, 2019

Rossi-Hansberg, Sarte, Trachter,
Rise in Institutional Ownership

From: "Eclipse of the Public Corporation or Eclipse of the Public Markets?"

by Craig Doidge, Kathleen M. Kahle, G. Andrew Karolyi, and René M. Stulz,
Common Ownership and Competition
• Issue: Common ownership of companies in the same industry by large
mutual-fund complexes leads those companies to compete against each other
less vigorously.
• Overview: Common Ownership in America
• https://corpgov.law.harvard.edu/2019/02/25/common-ownership-in-america-
1980-2017/ and links there.
• "Common Ownership Does Not Have Anti-Competitive Effects in the Airline
Industry," by Patrick Dennis, Kristopher Gerardi and Carola Schenone more
at: https://carolaschenone.com/research/
• "Anti-Competitive Effects of Common Ownership" by Jose Azar, Martin
Schmalz and Isabel Tecu) shows that common ownership of natural
competitors by diversified asset managers predicts higher product prices -
Journal of Finance, 2018 + replication package at:
https://sites.google.com/site/joseazar/
 Overview: Trading and Markets
• What are trading or transactions costs?
• Who trades in financial markets and why do they trade?
- roles of different market participants: investors, brokers, dealers,
arbitrageurs, retail traders, buy-side traders (institutions), day
traders, rogue traders and gamblers.
• How do you place orders to buy and sell securities?
- Different order types: limit orders, market orders, and stop orders;
and trading strategies: program trading, basket trading, block
trading, and short sales.
• How are markets structured for trading?
- market structures: single price auctions, open outcry auctions,
screen-based markets, and brokered markets.
• Exchanges as a business: the NYSE and NASDAQ and the
changing current situation.
 Securities Markets-Some Basics
• Security Market: place where traders gather to trade securities;
e.g.. LIFFE, NYSE or the Forex Market.
• Trading is a search process: as a buyer or seller you need to
find a counter-party; price, quantity and time to the trade are key
factors.
• Dealers or brokers help people trade
- Dealers are willing to take the other side on demand; quote a
bid (buy) price and a offer (ask) price; profit from the spread.
- Dealers acquire their client’s position and then try to trade
them at a profit.
- Brokers are agents who help traders search for counter
parties; profit through commissions.
• Security markets designed to reduce counterparty search cost.
 Trading partners

Buyer Seller

Buyer Dealer Seller

Buyer Seller

Agent Agent
Exchange
 Bid-Ask and Market Maker
Bid Price lower
than
Ask Price Market
(Buy Low and Sell
Dear)
Maker

BID PRICE ASK PRICE (or

Market Maker OFFER PRICE)
willing to Buy Spread Market Maker
from Customer Ask-Bid Willing to sell
to Customer

Sells Asset Buys Asset

Receives Bid Pays Ask Price
Price
Customer
 What is the Bid-Ask Spread made up of ?
Inventory Cost Transactions
Transactions Cost (taxes, Costs – Taxes,
fees etc) Car Fees etc that
Adverse Selection Costs the Dealer has
Dealer to bear

BID PRICE ASK PRICE

Dealer willing to
Buy your Spread
second hand Ask-Bid
car at this price
Inventory Costs- opportunity
costs of buying cars and
keeping them in the garage till
a Buyer is found
Dealer Willing to
sell you a
second hand car
at this price
Dealer does not know
“true value” of the car-
is it a “lemon” only the
seller know that
 Bid-Ask Spreads
• Trade in securities markets typically occurs at two
prices: the Bid and the Ask .
- A market maker offers to buy at the bid and sell at
the ask.
- A limit order to buy can be placed as a bid and a
limit order to sell can be placed as at the ask.
- A trader can buy immediately at the ask and sell
immediately at the bid.
• Why a bid-ask spread?
- transactions costs
- inventory costs
- adverse selection costs
 Posted v. Effective Spreads
• Spread (Bid-Ask) is in Multiples of “Tick” Size.
• Transaction Price = Actual Trade Price.
• If Trades take place Between the Bid and the Ask Posted ??

Spread overstates the Trading Cost (happens frequently ~12 to

31% of trades on the NYSE).
• Other Trading Costs: Broker’s Commissions, Legal Charges,
Exchange Fees etc.
• Trading Costs important for emerging market firms that want
listing on US or European Exchanges: how liquid is the market
for these shares? Other costs: increased disclosure, compliance
with US or UK legal formalities- Benefits include exposure, lower
costs of capital, easier to raise capital.
 Ask
Tick

Spread Cost

Tick

Bid
Why Do People Trade?- Some Stylized Traders
• Utilitarian Traders trade because they expect some utility from
trading besides trading profits.
- Examples: borrowers, investors,asset exchangers, hedgers etc.
• Profit-motivated Traders trade because they expect to profit.
- Examples: speculators, informed traders, technical traders, dealers etc.
• Futile Traders expect to profit from trading but they do not profit
on average.
- Examples: Inefficient traders ; pseudo-informed traders; rogue traders.

Real World Trader Behaviour is Complex

• People trade for reasons which are not necessarily mutually

exclusive but its easier to model “stylized” behaviour.
 Traders who are Hedgers
• Economic activity exposes individuals and firms to financial risk:
• Wheat farmer: faces risk of low wheat prices at the July harvest.
• Flour manufacturer: wishes to avoid a rise in wheat prices in July.
• Natural hedge possible as these two risks are complementary.
Hedging the Price Risk
• Farmer sells a July wheat futures contract fixing the cost of his
output in July; Flour manufacturer buys a wheat futures contract
thus fixing his input price in July.
• Both parties benefit by being able to reduce their net risk
exposure.
• Although the futures contract by itself may be very risky, when
used in these hedges, it reduces overall risk.
• Are such hedges likely to be perfect? What are the possible
problems?
 Orders and Order Properties
• Orders are instructions traders give to brokers and/or exchanges
explaining how their trades should be arranged.
- Highly standardized to save time and avoid mistakes.
- Represent traders interests even when not physically present s:
• Motivation
- Traders use orders to communicate their intentions.
- Exchange fix rules to a set of orders.
- Order submission strategy affects trading profits + liquidity.
• Orders always specify • Orders may specify
- Item to be traded - Price conditions
- Quantity - Method
- Side - Expiration
• Buy order bid. - Market
• Sell order offer.
- Counterparties
Limit Order Book
 Some Order Types
• Market order instructs the brokers to trade at the best price currently
available.
An Example

• Suppose the quote is 100 bid, 102 offer.

• Given no further information, best estimate of the “true” value is 101.
- A market order buyer who trades at 102 pays 101 for security value and 1
for immediacy.
- A market order seller who trades at 100 receives 101 for security value
and 1 for immediacy.
• Limit order instructs the broker to trade at the best price available but
to not violate the limit price condition:
- Do not buy at a price above the limit price.
- Do not sell at a price below the limit price.
• Limit order is an instruction to trade at the best price available; but
only if is no worse than a limit price specified by the trader.
• Buy limit order: trade price must be at or below the limit price.
• Sell limit order: price must be at or above the limit price.
 Other Types of Orders
Special Orders

• Stop orders (instructions)

• Tick sensitive orders
• Short sale orders
• Specialist participation orders
• Program orders
• Substitution orders
Stop Orders

• Stop orders are price-contingent orders.

ü Get activated when their price contingency is met.
ü Almost always market orders.
ü Typically are used to close losing positions.
Trading: Long & Short positions, Margin trading
• Long Position: Investor buys and holds securities
• “Buy low and sell high” - Make money when prices go up
• Short Position: Sell a security you do not own-profit of price drops
further.
• Margin Trading
⎻ Uses borrowed funds to purchase securities
⎻ Currently owned securities used as collateral for margin loan from
broker
⎻ Margin requirements set by Federal Reserve Board
⎻ Determines the minimum amount of equity required
⎻ On $4,445 purchase with 50% margin requirement, investor puts
up $2,222.50 and broker will lend remaining $2,222.50
⎻ Can be used for common stocks, preferred stocks, bonds, mutual
funds, options, warrants and futures
Initial Margin Requirements for Various Types of Securities
Margin Trading
• Pros: Allows use of financial leverage - Magnifies
profits
• Cons- Magnifies losses, Interest expense on margin
loan, Margin calls
Basic Margin Formula
Value of securities − Debit balance
Margin =
Value of securities
V − D
=
V
V − D $6,500 − $1,200
Margin = = = 0.815 = 81.5%
V $6,500
Margin Formulas
• Basic Margin Formula

Value of securities − Debit balance

Margin =
Value of securities
V − D
=
V
• Example of Using Margin

V − D $6,500 − $1,200
Margin = = = 0.815 = 81.5%
V $6,500

The examples, that follow, are only illustrative –in actual practice things are usually
more complicated
The Effect of Margin Trading on Security Returns
Typical Margin Formulas
• Return on Invested Capital

Total Total Market Market

current interest value of value of
− + −
Return on income paid on securities securities
invested capital received margin loan at sale at purchase
=
from a margin Amount of equity at purchase
transaction

• Example of Return on Invested Capital

Return on
invested capital $100 − $125 + $7,500 − $5,000 $2,475
= = = 0.99 = 99%
from a margin $2,500 $2,500
transaction
Short Selling
• Short Selling
– Investor sells securities they don’t own
– Investor borrows securities from broker
– Broker lends securities owned by other investors – known as the
“stock lending market”.
• Investors profit when the stock price goes down but unlimited losses
if the stock price goes up.
• In practice short selling is a complicated transaction with various fees
to be paid and conditions to be fulfilled by the short seller.
• More nitty-gritty details available in this SEC 2014 Report:
• https://www.sec.gov/dera/reportspubs/special-studies/short-sale-
position-and-transaction-reporting.pdf
Mechanics of a Short Sale-1
Margin Positions on Short Sale -2
 Other Things Orders Must Specify
• Validity Instructions: Indicate how long the order remains
option (good).
- Good-till-cancel orders remain open indefinitely.
- Good-until orders specify an expiration date.
- Day orders expire at day-end.
- Immediate-or-cancel, good-on-sight orders and fill-or-kill orders expire
immediately following presentation.
• Quantity Instructions: How large orders can be broken into
small trades.
- All-or-none orders must be completely filled.
- Minimum partial fill restrictions reduce settlement costs.
• Timing Instructions: Restrict the execution window.
- Market-on-close orders; Some mutual funds like to trade at closing prices.
- Market-on-open orders.
• Execution instructions: Tell the broker how to arrange the
trade.
- Market-not-held is a market order that the broker need not immediately
execute or expose. The broker is expected to use discretion to find the
best price.
 Market Structure
• Trades take place during the trading session.
• Execution system matches the buyers with the sellers.
• Information systems bring information into and out of the market.
ü Trading Sessions
– Continuous markets arrange trades continuously as orders
arrive.
– Call markets collect orders for batch processing.
– Trading hours: open and close
ü Execution System Types
– Quote-driven markets are primarily organised by dealers.
– Order-driven markets (auction markets) are organised by
exchanges.
– Brokered markets organised by brokers
 Market Architecture
• Securities also trade in a hybrid environment of market
designs or architectures.
• Nasdaq: Interdealer electronic network
• NYSE: Floor based auction organized by a specialist
• ECNs (ATS): Electronic networks with no dealer
intermediaries (e.g. Archipelago, Instinet)
• Open outcry: CME, CBOT futures pits, Treasury
phone based market
 Electronic Communication Networks
Electronic communication networks (ECNs) are alternative
trading systems (ATS) that match buying and selling
interest automatically without dealer intermediation.

They have become the predominant trading

mechanism in both equities and foreign exchange.

70 70

60 60

50 50

Percentage of Transactions
Market Share
40 40

30 30

20 20

10 10

0 0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 1989 1992 1995
Year
1998 2001 2004 *
Year

Nasdaq ECN share FX market share

Logistics Topics Policies Exams & Grades Mathematical Finance Algorithmic Trading Execution Strategies Trading Types

Trading Process
Practical Issues with Data
Given the size and history of financial markets good quality data is
available but care needed in empirical work:

1 Back fill bias - when data is added during the current period and
historical data are also added at that time.For example, mutual funds
added after they start doing well - upwardly biasing their returns.

2 Restatement.For example, data revision in macroeconomic data like

consumption or gap etc.

3 Survivorship bias when only currently existing firm data is reported not
that of firms that die or no longer exist.

4 Lookahead bias - when data is used at time T when it would be

available only at T+1.

Finally, the elephant in the room is data mining (a.k.a. p-hacking) -

has always been an issue but more awareness recently .
Using Individual Stocks or Portfolios?

The U.S. stock market has around 4000-6000 listed stocks. This
creates its own problems.

Individual stock data is both noisy (measurement issues like bid-ask

spreads) and correlated.

In empirical work stocks are sorted in to portfolios - reduces

dimension of the problems and diversification washes out most of the
idiosyncratic firm level effects.

Dealing with outliers is also a problem with individual stock data -

incorrect data is a possibility- winsorizing or other methods are
commonly used -but we may also be throwing away information.
Portfolio Sorts
Start with return data on each stock for every time period in the
sample.

Obtain data on another individual stock characteristic - say market

capitalisation (Mcap) = number of shares outstanding x stock price

Sort stocks on each firms Mcap.

Use the max. and min. MCap to create quintiles or deciles as

required.

In each, say decile, create equal or value weighted portfolios and

compute the return of each portfolio.

This is essentially a (non-parametric conditional) sort - think of the

deciles as a histogram- each portfolio is consist of stocks with returns
in that decile.
Sorting ⇢E(Rit|BtoMcap) ⇢non-parametric (histogram)
Algorithmic Trading Strategies Optimal Execution Benchmark-Driven Schedules Cost-Driven Schedules What is Next? The High

The Market in Numbers

US Equities volumes: 5 and 10 billion shares per day

1.2 ∼ 2.5 Trillion shares per year

Annual volume: USD 30 ∼ 70 trillion

At least 30% of the volume is algorithmic: 360 ∼ 750 billion

shares/year

Typical large “sell side broker trades between 1 and 5 USD Tri
per year using algos

Each day, between 15,000 and 30,000 orders are processed

An algorithmic execution strategy can be divided into 500 ∼

1,000 small daughter orders
Listed Stocks on U.S. Exchanges: #’s over time
Largest Market Value Stocks on U.S. Exchanges
US Stock Deciles by mkt. cap. (NYSE)
 US bull and bear markets GTM – UK | 50
S&P 500 declines from all-time highs, %
0
-10
-20
-30 4
7 20% market
-40 8 decline
5
-50 6 9
-60 10
3 Recession
-70
-80 2

-90 1
-100
Equities

'28 '33 '38 '43 '48 '53 '58 '63 '68 '73 '78 '83 '88 '93 '98 '03 '08 '13

Characteristics of past bear and bull markets*

Macro
Bear markets Bull markets Return before peak
environment
Market corrections
Market Bear Duration Bull Bull Duration 12 24
peak return (months) Recession start date return (months) months months
1 Crash of 1929 – excessive leverage, irrational exuberance Sep 1929 -86% 33 - - -
2 1937 Fed Tightening – premature policy tightening Mar 1937 -60 63 Jun 1932 324% 58 27% 119%
3 Post WWII crash – post-war demobilisation, recession fears May 1946 -30 37 Apr 1942 158 50 27 57
4 Flash crash of 1962 – flash crash, Cuban Missile Crisis Dec 1961 -28 7 Jun 1949 436 152 28 23
5 Tech crash of 1970 – economic overheating, civil unrest Nov 1968 -36 18 Jun 1962 107 78 15 35
6 Stagflation – OPEC oil embargo Jan 1973 -48 21 May 1970 74 32 16 31
7 Volcker Tightening – campaign against inflation Nov 1980 -27 21 Oct 1974 126 75 32 48
8 1987 crash – programme trading, overheating markets Aug 1987 -34 3 Aug 1982 229 61 36 80
9 Tech bubble – extreme valuations, “dot com” boom/bust Mar 2000 -49 31 Dec 1987 582 150 19 39
10 Global Financial Crisis – leverage/housing, Lehman collapse Oct 2007 -57 17 Oct 2002 101 61 16 31
Current cycle – – – Mar 2009 295 106
MEDIAN – - 42% 21 158% 68 27% 39%

Source: Bloomberg, NBER, Robert Shiller, Standard & Poor’s, J.P. Morgan Asset Management. *A bear market represents a 20% or more decline from the previous
market high using a monthly frequency; a bull market represents a 20% increase from a market trough. Periods of “recession” are defined using US National Bureau of
Economic Research (NBER) business cycle dates. Chart and table shows price return. Past performance is not a reliable indicator of current and future results.
Guide to the Markets - UK. Data as of 31 December 2017.

50
 Government bonds GTM – UK | 62
10-year government bond yields US yield curve
% %, 10-year yield minus Fed funds rate Recession
18 6
US
4
16 UK 2
Germany 0
14 -2
Japan
-4
12
-6
-8
10 '71 '75 '79 '83 '87 '91 '95 '99 '03 '07 '11 '15

8 Global government bond yields

Fixed income

% of BofA/Merrill Lynch Global Government Bond Index

6 80 Yield below 1%
Yield below 0%
4 60

2 40

0 20

-2 0
'80 '84 '88 '92 '96 '00 '04 '08 '12 '16 '14 '15 '16 '17

Source: (Left) Thomson Reuters Datastream, J.P. Morgan Asset Management. (Top right) Bloomberg, Thomson Reuters Datastream, US Federal Reserve,
J.P. Morgan Asset Management. Light grey columns indicate recessions determined by NBER. (Bottom right) Bloomberg, BofA/Merrill Lynch, J.P. Morgan Asset
Management. Past performance is not a reliable indicator of current and future results. Guide to the Markets - UK. Data as of 31 December 2017.

62
 Data and Empirical Finance-1
• In contrast to other areas of economics, finance researchers
have access to financial market data huge volumes of data and of
observed variable like market determined prices.
• However, this can both be a blessing and a curse!

• Traditional sources of firm-level data are CRSP for stocks market

data and COMPUSTAT for firm-level accounting data – CRSP from
1925 and COMPUSTAT of good quality from 1963.
• Data for the rest of the world is available but is of varying quality
and coverage.
• These are expensive, commercial data sets.
 Data and Empirical Finance-2
• Data is available for other markets like futures, options, bonds both
corporate and government but largely only after the 1990s.
• This data is also commercial and expensive but the advantage is it is
cleaned and can be organized using code in SAS, Python and R.
• Empirical finance also uses data on macroeconomic variables – this is
available from FRED for the U.S. and other sources for different
countries like the IMF, OECD etc.
• Forecast and sentiment data from Michigan, FRED, and Analysts
Forecast from IBES are other data sources that are used.
• The new trend is to go to the original source like SEC filings, download
the entire original data and extract it using Python or R. rather
incorrectly called “hand collected” data!
 Data and Empirical Finance -3
• Many prominent databases have serious
shortcomings which can affect the quality of
research output and the reliability of results. In
empirical work:
• Careful exploratory analysis
• Working on where the original data is from and
how it has been organized is very important.
• Missing data treatment, backfilling of historical
data etc.
 Data and Empirical Research-4
• There now at least (!) two major issues in empirical finance and
of course in other areas of empirical economics.

• Replicability: There is a movement to get authors to provide data

and code that can replicate their results. Some journals enforce
this(AER, Econometrica) but less so in top field journals. However,
it may become obligatory in the near future.

• Data mining: there are literally thousands of researchers that test

a hypothesis using the same data. This gives rise to the problem
of p-hacking and false discovery i.e. standard statistical tests
using p=0.05 level of significance may be misleading.
Some references for further reading
• Prof. Joel Hasbrouck: http://people.stern.nyu.edu/jhasbrou/
• Draft book (free): Securities Trading: Principles and Procedures
• Other useful links: Market microstructure conference – flavour of
current work in theory and empirics.
• Lawrence, Harris: Trading and Exchanges Market Microstructure
for Practitioners, OUP, 2002.
• Recent Theoretical Work on High Frequency Trading:
• Budish, Cramton, Shim, 2015, The High-Frequency Trading Arms
Race: Frequent Batch Auctions as a Market Design Response,
Quarterly Journal of Economics 130(4), Nov 2015, pp 1547-1621.