The Microstructure Age

In recent years, the availability of high-quality, high-frequency data has revolutionised the study of financial markets. By providing a detailed description not only of asset prices, but also of market participants’ actions and interactions, this wealth of information offers a new window into the inner workings of the financial ecosystem. As access to such data has become increasingly widespread, study of this field – which is widely known as market microstructure – has blossomed, resulting in a growing research community and growing literature on the topic.

Accompanying these research efforts has been an explosion of interest from market practitioners, for whom understanding market microstructure offers many practical benefits, including managing the execution costs of trades, monitoring market impact and deriving optimal trading strategies. Similar questions are of vital importance for regulators, who seek to ensure that financial markets fulfil their core purpose of facilitating fair and orderly trade. The work of regulators has come under increasing scrutiny since the rapid uptake of high-frequency trading, which popular media outlets seem to fear and revere in ever-changing proportions. Only with a detailed knowledge of the intricate workings of financial markets can regulators tackle these challenges in a scientifically rigorous manner.

Compared to economics and mathematical finance, the study of market microstructure is still in its infancy. Indeed, during the early stages of this project, all four authors shared concerns that the field might be too young for us to be able to produce a self-contained manuscript on the topic. To assess the lay of the land, we decided to sketch out some ideas and draft a preliminary outline. In doing so, it quickly became apparent that our concerns were ill-founded, and that although far from complete, the story of market microstructure is already extremely compelling.We hope that the present book does justice both to the main developments in the field and to our strong belief that they represent a truly new era in the understanding of financial markets.

What is Market Microstructure?

Before we embark on our journey, we pause for a moment to ask the question: What is market microstructure? As the name suggests, market microstructure is certainly concerned with the details of trading at the micro-scale. However, this definition does little justice to the breadth of issues and themes that this field seeks to address.