Exchange Trading Rules Douglas Cumming Schulich School of Business York University, Toronto, Canada Sofia Johan Tilburg Law and Economics Center (TILEC)

Exchange Trading RulesExchange Trading Rules

Douglas CummingDouglas CummingSchulich School of BusinessSchulich School of Business

York University, Toronto, CanadaYork University, Toronto, Canada

Sofia JohanSofia JohanTilburg Law and Economics Center (TILEC)Tilburg Law and Economics Center (TILEC)

Tilburg University, The NetherlandsTilburg University, The Netherlands

Research QuestionResearch Question

Vague versus detailed rulesVague versus detailed rules

Context: equity stock exchangesContext: equity stock exchanges

Do detailed trading rules facilitate Do detailed trading rules facilitate trading?trading?• Enhance investor confidence that the Enhance investor confidence that the

risk of manipulation has been mitigatedrisk of manipulation has been mitigated

Prior WorkPrior Work Aitken and Siow (2003 Hewlett-Packard Handbook Aitken and Siow (2003 Hewlett-Packard Handbook

of World Stock, Derivative & Commodity Exchanges)of World Stock, Derivative & Commodity Exchanges)• Rank markets based on efficient and integrityRank markets based on efficient and integrity

La Porta et al. (2006 Journal of Finance)La Porta et al. (2006 Journal of Finance)• Public enforcement of securities laws does little to help the Public enforcement of securities laws does little to help the

development of stock marketsdevelopment of stock markets• Private enforcement and disclosure rules help stock Private enforcement and disclosure rules help stock

marketsmarkets

Cumming and Johan (2008 American Law and Cumming and Johan (2008 American Law and Economics Review)Economics Review)• First look at international differences in surveillanceFirst look at international differences in surveillance• Cross-market surveillance and information sharing helps Cross-market surveillance and information sharing helps

development of stock marketsdevelopment of stock markets

New ContributionsNew Contributions

First look at exchange trading rules across First look at exchange trading rules across countries and timecountries and time

Relate trading rules to trading velocityRelate trading rules to trading velocity Trading RulesTrading Rules

• Insider tradingInsider trading• Market ManipulationMarket Manipulation

Price ManipulationPrice Manipulation Volume ManipulationVolume Manipulation SpoofingSpoofing False Dissemination False Dissemination

• Broker agency conductBroker agency conduct

What Are Business Trading Rules?What Are Business Trading Rules?

Found on the stock exchange webpageFound on the stock exchange webpage

Like a contract between all stock Like a contract between all stock exchange trading participantsexchange trading participants

Some exchanges have vague rulesSome exchanges have vague rules(“thou shalt not manipulate the market”)(“thou shalt not manipulate the market”)

Other exchanges precisely set out exactly Other exchanges precisely set out exactly what they mean by manipulation in the what they mean by manipulation in the rules…rules…

Insider Trading RulesInsider Trading Rules

FrontrunningFrontrunning Client PrecedenceClient Precedence Trading Ahead of Research ReportsTrading Ahead of Research Reports Separations of Research and TradingSeparations of Research and Trading Broker Ownership LimitBroker Ownership Limit Restrictions on AffiliationRestrictions on Affiliation Restrictions on CommunicationsRestrictions on Communications Investment Company SecuritiesInvestment Company Securities Influencing or Rewarding Employees of OthersInfluencing or Rewarding Employees of Others Anti-Intimidation/ CoordinationAnti-Intimidation/ Coordination

Market Manipulation RulesMarket Manipulation Rules

Price ManipulationPrice Manipulation

Volume ManipulationVolume Manipulation

SpoofingSpoofing

False DisseminationFalse Dissemination

Price ManipulationPrice Manipulation

Marking the OpenMarking the Open Marking the CloseMarking the Close Misleading End of Month/Quarter/Year Misleading End of Month/Quarter/Year

TradesTrades Intraday Ramping/ GougingIntraday Ramping/ Gouging Market SettingMarket Setting Pre-Arranged TradesPre-Arranged Trades Domination and ControlDomination and Control

Volume ManipulationVolume Manipulation

ChurningChurning

Wash TradesWash Trades

SpoofingSpoofing

Giving up PriorityGiving up Priority

SwitchSwitch

Layering of Bids/AsksLayering of Bids/Asks

False DisseminationFalse Dissemination

Dissemination of False and Dissemination of False and Misleading InformationMisleading Information

Parking or WarehousingParking or Warehousing

Broker Agency ConductBroker Agency Conduct

Trade ThroughTrade Through Improper ExecutionImproper Execution Restrictions on Member Use of Restrictions on Member Use of

Exchange NameExchange Name Restrictions on Sales Materials and Restrictions on Sales Materials and

TelemarketingTelemarketing Fair Dealing with CustomersFair Dealing with Customers

New Indices in this PaperNew Indices in this PaperAcross Countries and TimeAcross Countries and Time

Insider TradingInsider Trading

Market ManipulationMarket Manipulation• Price ManipulationPrice Manipulation• Volume ManipulationVolume Manipulation• SpoofingSpoofing• False DisseminationFalse Dissemination

Broker Agency ConflictBroker Agency Conflict

Trading VelocityTrading Velocity Accounts for market size… makes different Accounts for market size… makes different

exchanges comparableexchanges comparable

tionCapitalizaMarket Domestic end-Month

Turnover Share Domestic Monthly

Table 3. Descriptive Statistics

This table presents descriptive statistics for the full sample of country-month observations in the data. The data span the months February 2006 - October 2008, and the exchanges listed in Table 2.

Mean MedianStandard Deviation Minimum Maximum

Number of Observations

Velocity 0.951 0.709 0.751 0.034 4.093 1363

Insider Trading Index 2.202 2 2.096 0 10 1363

Market Manipulation Index 5.266 4 4.036 0 13 1363

Price Manipulation Index 2.627 2 2.268 0 7 1363

Volume Manipulation Index 0.691 1 0.710 0 2 1363

Spoofing Index 1.242 1 1.019 0 3 1363

False Disclosure Index 0.707 1 0.583 0 2 1363

Broker Agency Index 0.836 0 1.240 0 5 1363

Investor Protection Index 2.344 2.337 0.826 0.686 3.775 1363

Log (1+MSCI) -0.001 0.009 0.057 -0.371 0.138 1363

Log (GDP) 9.500 10.164 1.332 6.565 11.304 1363

Comparison TestsComparison Tests

Difference in means and mediansDifference in means and medians

Panel A: All countriesPanel A: All countries

Panel B: Subset of Mifid CountriesPanel B: Subset of Mifid Countries

Panel C: Pre- versus Post-MifidPanel C: Pre- versus Post-Mifid

Panel A. All Countries

Insider Trading Index Market Manipulation Index Broker Agency IndexInvestor Protection

Index

>1 <=1 >5 <=5 >0 =0 >2 <=2


883 480 537 826 526 837 891 472

Mean 1.07 0.74 1.17 0.81 0.92 0.97 0.99 0.88

Standard Deviation

0.84 0.49 0.75 0.72 0.82 0.70 0.81 0.61

Median 0.81 0.60 0.93 0.53 0.68 0.74 0.78 0.63

Difference in Means

8.963*** 8.986*** -1.087 2.946***

Difference in Medians

p <= 0.000*** p <= 0.000*** p <= 0.171 p <= 0.000***

Panel B. Subset of MiFID Countries

Insider Trading IndexMarket Manipulation

Index Broker Agency IndexInvestor Protection

Index

>1 <=1 >5 <=5 >0 =0 >2 <=2

Number of Observations 312 84 207 189 87 309 198 198

Mean 1.227 1.026 1.186 1.183 1.366 1.133 1.341 1.028

Standard Deviation 0.562 0.505 0.596 0.510 0.316 0.597 0.333 0.678

Median 1.365 0.957 1.357 1.206 1.352 1.292 1.383 0.717

Difference in Means 3.158*** 0.062 4.835*** 5.826***

Difference in Medians p <= 0.000*** p <= 0.028 ** p <= 0.067* p <= 0.000***

Panel C. Pre-MiFID versus Post-MiFID

Non-MiFID Countries MiFID Countries

Post-MiFID Pre-MiFID Post-MiFID Pre-MiFID

Number of Observations 358 609 144 252

Mean 0.895 0.832 1.267 1.137

Standard Deviation 0.841 0.772 0.581 0.537

Median 0.679 0.563 1.373 1.276

Difference in Means 1.167 2.200***

Difference in Medians p <= 0.019*** p <= 0.025**

OLS RegressionsOLS Regressions

Trading Velocity is a function ofTrading Velocity is a function of• Insider Trading IndexInsider Trading Index• Market Manipulation IndexMarket Manipulation Index• Broker Conflict IndexBroker Conflict Index• LLSV (1998, 2006) IndicesLLSV (1998, 2006) Indices• GDP per capita (annual lagged)GDP per capita (annual lagged)• MSCI Index (monthly lagged)MSCI Index (monthly lagged)

RobustnessRobustness• Country dummy variables & fixed effectsCountry dummy variables & fixed effects• Difference-in-differencesDifference-in-differences• Endogeneity considered laterEndogeneity considered later

Table 6

Model (1) Model (2) Model (3) Model (4) Model (5)

Coefficient

t-statisticCoeffici

entt-

statisticCoeffici

entt-

statisticCoefficie

ntt-

statisticCoefficie

ntt-statistic

Constant -1.588 -1.850* 0.05423.938

***1.763

2.026**

1.836 2.150**

Country Dummy Variables

Yes Yes Yes No Yes

Country Fixed Effects

No No No Yes No

AR(1) Model Yes No Yes Yes Yes

After*Treat 0.052 4.018*** 0.1213.038*

**

Treat 3.45517.620**

*0.908

8.867***

Insider Trading Index

0.0374.005*

**0.017 1.866*

Market Manipulation

Index 0.005 3.356***

Log (1+MSCI) -0.080-

4.464***-0.159 -1.244 -0.081

-4.526*

**-0.025 -1.352 -0.083

-4.624***


1363 1363 1363 1363 1363

Adjusted R2 0.88 0.88 0.88 0.87 0.88


Table 6Coeffici

entt-

statisticCoeffici

entt-

statisticCoeffici

entt-

statisticCoefficie

ntt-

statisticCoefficie

ntt-statistic

Constant 1.8472.174*

*1.858

2.203**

1.8522.155*

*1.824 1.995** 1.958 2.058**

Country Dummy Variables

Yes Yes Yes Yes Yes

Country Fixed Effects

No No No No No

AR(1) Model Yes Yes Yes Yes Yes

Price Index 0.0083.490*

**

Volume Index 0.0362.059*

*

Spoofing Index 0.0213.073*

**

False Disclosure Index

0.0522.811**

*

Broker Agency Index -0.019 -0.413

Log (1+MSCI) -0.083-

4.585***

-0.087-

4.855***

-0.084-

4.683***

-0.084-

4.663***

-0.088-

4.862***


1363 1363 1363 1363 1363

Adjusted R2 0.88 0.88 0.88 0.88 0.88


Table 6Coeffici

entt-

statisticCoeffici

entt-

statisticCoeffici

entt-

statisticCoefficie

ntt-

statisticCoefficie

nt t-statistic

Constant -1.904

-9.738**

* -1.850

-9.298**

* -1.975

-9.532**

* -1.944 -9.337*** -1.987-

10.299***Country Dummy

Variables No No No No NoCountry Fixed

Effects No No No No No

AR(1) Model Yes Yes Yes Yes Yes

Insider Trading Index 0.17719.856*

** 0.17217.589*

** 0.14310.468*

** 0.14410.582**

* 0.169 18.392***

Market Manipulation Index 0.005 1.330 0.008 2.115** 0.007 1.889*

Broker Agency Index 0.0652.949**

* 0.035 1.455

Investor Protection Index 0.072 2.977*** 0.183 7.720***

Efficiency of the Judiciary -0.099 -9.536***

Log (1+MSCI) -0.040 -0.733 -0.029 -0.522 -0.032 -0.594 -0.039 -0.724 -0.047 -0.907

Log (GDP) 0.26120.362*

** 0.25418.265*

** 0.26618.404*

** 0.24815.816**

* 0.306 21.492***Number of

Observations 1363 1363 1363 1363 1363

Adjusted R2 0.26 0.27 0.28 0.29 0.32

IV EstimatesIV Estimates

Rules Rules Velocity Velocity

Velocity Velocity Rules Rules

Use instruments very similar to that Use instruments very similar to that in La Porta et al. (2006):in La Porta et al. (2006):• English Legal OriginEnglish Legal Origin• RepudiationRepudiation• Efficiency of the JudiciaryEfficiency of the Judiciary

First Stage IV Estimates Second Stage IV Estimates

Table 7(16) Market

Manipulation Index

(17) Insider Trading Index

(18) Investor Protection Index

(19) Velocity (20) Velocity

Coeffici

entt-

statisticCoeffici

entt-

statisticCoeffici

entt-

statisticCoeffici

ent

t-statisti

c

Coefficient

t-statistic

Constant -12.871-

3.977***

-0.682 -0.350 1.5102.207*

*0.536 1.817* 2.276 1.667*

Log GDP per Capita 1.011 1.371 0.012 0.041 -0.021 -0.221

English Legal Origin 0.581 0.546 0.610 0.924 0.9863.993*

**

Repudiation Index 1.3952.617**

*0.040 0.177 -0.013 -0.140

Efficiency of the Judiciary

-0.173 -0.553 0.319 1.850* 0.095 1.149 -0.094-

1.874*-0.079 -1.522

Market Manipulation Index (fitted values for

Models 19-22)0.167

6.147***

0.2463.210**

*

Log (1+MSCI) 3.522 0.430 -1.274 -0.160

Log (GDP) -0.236 -1.311


42 42 42 42 42

Adjusted R2 0.45 0.08 0.41 0.41 0.31

Second Stage IV Estimates OLS Estimates without Instruments

Model (21) Model (22) Model (23) Model (24) Model (25)Coeffici

entt-

statisticCoeffici

entt-

statisticCoeffici

entt-

statisticCoeffici

entt-

statisticCoeffici

entt-

statistic

Constant 2.198 1.749* 2.599 1.797* -1.156 -1.734* -1.572-

1.968**

-1.234 -1.794*

Efficiency of the Judiciary

0.062 0.374 -0.032 -0.487 -0.064 -1.312 -0.119-

2.405**

-0.086 -1.770*

Insider Trading Index (fitted values for Models 19-22)

-0.351 -0.843 0.143 1.865*

Market Manipulation Index (fitted values for Models 19-22)

0.2593.304**

*0.247 3.373** 0.047 1.715* 0.014 0.438 0.050 1.812*

Investor Protection Index (fitted values for Models 19-22)

-0.210 -0.843 0.098 0.608

Log (1+MSCI) 0.111 0.013 0.111 0.013 8.322 0.867 8.377 0.935 7.097 0.663

Log (GDP) -0.265 -1.425 -0.262 -1.421 0.224 2.402** 0.2982.713*

**0.227 2.420**


42 42 42 42 42

Adjusted R2 0.31 0.39 0.18 0.27 0.17

Summary of Key ResultSummary of Key Result Exchange trading rules a very statistically significant and robust Exchange trading rules a very statistically significant and robust

factorfactor

Insider Trading Rules greatest economic significance:Insider Trading Rules greatest economic significance:• Each rule increases velocity by at least 3% depending on the specificationEach rule increases velocity by at least 3% depending on the specification

Market Manipulation Rules also economically significantMarket Manipulation Rules also economically significant• Each rule increases velocity by at least 1% depending on the specificationEach rule increases velocity by at least 1% depending on the specification

Economic significance is even greater with the IV estimates.Economic significance is even greater with the IV estimates.

Example: Example: • Euronext Paris (138.57%) versus Hong Kong (95.32%)Euronext Paris (138.57%) versus Hong Kong (95.32%)• Actual difference: 43.25%Actual difference: 43.25%• Predicted difference for Insider Trading Rules (simple Predicted difference for Insider Trading Rules (simple

regression): 31.2%regression): 31.2%• Predicted difference for Market Manipulation Rules (simple Predicted difference for Market Manipulation Rules (simple

regression): 45.18%regression): 45.18%

-2

-1.5

-1

-0.5

0

0.5

1

1.5

2

2.5

-6 -4 -2 0 2 4 6 8

Figure 1. Partial Regression Plot of Velocity and Insider Trading Rules Index

NASDAQ

Malaysia

NYSE

Jordan

Residual Insider Trading Rules Index

Resi

dual

Vel

ocity

Spain

Sri Lanka

OMXIndonesia

Argentina

Italy

Korea

GreeceMexico

Oslo

Germany

Slovenia

Thailand

India NSE

Switzerland

Shanghai

Shenzhen

NewZealand

LondonParis

Brazil

Bermuda

Bombay

Turkey

Ireland

AustriaToronto

PhilippinesAustralia

Singapore

Egypt

PeruColumbia

Taiwan

Israel

Tokyo

Chile

Hong Kong

Figure 1. Partial Regression Plot of Velocity and Insider Trading Rules Index. This figure presents a partial regression plot of velocity and the Insider Trading Rules Index. The independent variables include the investor protection index (La Porta et al., 2006), the Efficiency of the Judiciary (La Porta et al., 1998), the log of MSCI and the log of GDP per capita. The coefficient is equal to 0.152, (robust) t-statistic 2.437 and adjusted R2 is 0.157.

-2

-1.5

-1

-0.5

0

0.5

1

1.5

2

2.5

-8 -6 -4 -2 0 2 4 6

Figure 2. Partial Regression Plot of Velocity and Market Manipulation Trading Rules Index

Resi

dual

Vel

ocity

Residual Market Manipulation Rules Index

IndiaNSE

Slovenia

NYSE

London

Spain

Thailand

Paris

Toronto

Italy

Ireland

Greece

NASDAQ

Bombay

Austria

Switzerland

Sri Lanka

OMX

Germany

Korea

Indonesia

Mexico

Egypt

Oslo

Argentina

Columbia

Shanghai

Shenzhen

Jordon

PhilippinesHongKong

Singapore

Peru

Brazil

MalaysiaAustralia

Bermuda

New ZealandChile

Turkey

Tokyo

Taiwan

Israel

Figure 2. Partial Regression Plot of Velocity and Market Manipulation Trading Rules Index. This figure presents a partial regression plot of velocity and the Market Manipulation Trading Rules Index. The independent variables include the investor protection Index (La Porta et al., 2006), the Efficiency of the Judiciary (La Porta et al., 1998), the log of MSCI and the log of GDP per capita. The coefficient is equal to 0.050, (robust) t-statistic 1.812 and adjusted R2 is 0.039.

ConclusionsConclusions Insider Trading and Market Manipulation Rules Insider Trading and Market Manipulation Rules

are an important element to encouraging are an important element to encouraging investors to trade on stock exchangesinvestors to trade on stock exchanges

Detailed rules facilitate tradingDetailed rules facilitate trading Vague rules in countries with high risk of Vague rules in countries with high risk of

repudiationrepudiation Not easy to change business rules, but possibleNot easy to change business rules, but possible

Mifid rules are an important benefit to trading on Mifid rules are an important benefit to trading on European ExchangesEuropean Exchanges

Documents

Exchange Trading Rules Douglas Cumming Schulich School of Business York University, Toronto, Canada Sofia Johan Tilburg Law and Economics Center (TILEC)