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CHAPTER

15

Trading Technology and Stock Market Liquidity

A Global Perspective
Pankaj K. Jain, and William F. Johnson

Abstract: We characterize the technological revolution that swept nancial markets around the world and assess its profound effects. Computerization and satellite communication have transformed the industrial organization of stock exchanges and dramatically improved secondary market liquidity. Trading turnover has undergone a manifold increase and transaction costs have declined sharply due to advances in technology and an increase in number of stock market participants supplying liquidity. Greater liquidity in equities has made stocks a more attractive investment vehicle for investors, thus lowering the cost of equity for listed companies. While technology has had profound positive effects for investors and companies, there have also been negative consequences associated with these innovations. We identify some determinants of these positive and negative variations in the effects of automation on liquidity.

15.1

HISTORY OF STOCK EXCHANGES AND TECHNOLOGY

At the most simplistic level, a marketplace is an arena for buyers and sellers to exchange goods, claims, or services. Stock markets are no exception. The rst organized exchange for nancial instruments was established in Germany in 1585 to primarily facilitate currency exchange rates from multiple coinages circulating throughout Europe then. The initial stock exchanges typically began in auspicious locations the London stock exchange which was originally located around a coffee shop while the rst exchangewhat became the New York Stock Exchange
Jain gratefully acknowledges support from the Suzanne Downs Palmer Professorship and from the Center for International Business Education and Research. Sneha Kollepara provided useful comments and suggestion.

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(NYSE) in the United States was organized along a Wall (erected to protect Dutch from British and Indian attacks) in New York and was intended to renance debt from the Revolutionary War. Looking back, it would be impossible for the original pioneers of nancial exchanges to even imagine what their seemingly simple actions would develop into today. As technology and nancial instruments evolved, the exchanges that provided trading services for these products became ever more sophisticated and advanced. Todays exchanges represent complex entities with a wide array of activities ranging from listing services, information production, price discovery, secondary market liquidity provision for equities and derivatives, clearing house services, data warehousing, and settlement services. Trading mechanisms have undergone a sea change. In 1817, the President of the NYSE would call out the security and then the traders would trade, each stock only trading at one time. Share volumes remained low ringing 1,534 shares in June 1837. The rst true technological advancement happened soon after in 1844, with the invention of the telegraph. For the rst time, individuals could participate in the security markets in real time and far outside of an exchange. In 1866, the transatlantic cable was completed and investors in the United States and Europe could trade, creating tremendous arbitrage opportunities. In an effort to increase liquidity, the NYSE introduced a specialist to facilitate trades in each security throughout the day ending the practice of trading single securities at set times during the day in 1871. New technologies also resulted in the expansion of trading hours. Trading was conducted from 10 a.m. to 2 p.m. in 1871 on NYSE. Since 2004, trading thrives between 9:30 a.m. to 6:30 p.m. during extended regular hours or four off-hours crossing sessions. Volumes of trades continued to increase rapidly as trading systems evolved, averaging over 4 million by 1961. When one tries to look for the pitfalls of new technology, trade disruptions and excess volatility are potential concerns. Exchange closures due to heavy volumes or technical glitches have become rare events now compared to their frequency in the past. NYSE was closed for three days in 1919 and 45 full or partial days between 1928 and 1933 to allow back ofces to catch up on work. Paperwork crisis resulted in four day weeks or curtailed hours throughout 1967 to 1970. Trading halts due to computer malfunctioning were witnessed seven times from 1974 to 1975, but became less frequent subsequently (once each in 1977, 1980, 1983, 1995, 1998, 2001, and 2005). Recent technology has almost eliminated trade disruptions, signicantly enhanced trading volumes, and lowered bid-ask spreads. The spreads, on average, have come down drastically throughout the century and will most likely continue to decrease as technology improves an exchanges ability to execute orders. Table 15.1 presents the liquidity levels surrounding the major stock market events. Our focus is on technological advancements (T) but we also consider regulations (R) and market sentiment or major scandals (S). All three types of developments are likely to have a signicant affect on market liquidity. Our liquidity measure is the proportional bid-ask spread: Proportional Quoted Spread = Ask Price Bid Price 100 Quote Midpoint (15.1)

where quote midpoint is calculated as (Bid Price + Ask Price)/2. Jones (2002) hand-collected a century of spreads from 1900 to 2000. We borrow the numbers from gure 1 of their paper. We append the spreads from 2001 to 2006

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TABLE 15.1 Technology (T), Regulatory Advancements (R), Financial Shocks, Optimistic
Sentiments or Scandals (S), and Liquidity on NYSE Spreads(BP) from Jones (2002) Change in Spreads

Year 1792

Description Buttonwood Agreement: 24 prominent brokers gather on Wall Street agreeing to trade securities on a commission basis. The New York Stock Exchange begins. Telegraph allows brokers outside of New York instant access to exchange. Trans-Atlantic cable provides instant communication between Europe and U.S. markets. Continuous trading via specialists replaces the older call auction trading system. First telephone installed on oor. The rst annunciator board is installed for paging members. Listed companies required to submit regular nancial statements. Move to current larger trading oor site. Dow Jones Industrial Average (DJIA) Index set all time high record of 100. Financial problems at Knickerbocker Trust triggers a run on banks. Kansas adopts Blue Sky law imposing registration requirements on issuers and brokers. Federal Reserve System established to control credit and bank stability. World War I causes exchange to close for 4 1 months. 2 An expanded pneumatic tube system goes into operation. Also, America emerges from the war as a creditor nation, and Wall Street supplants London as the world investment capital. Centralized clearing system established. Fraud Bureau established to eliminate stock market gamblers and fraudulent security sales. Start of a bull market. Listing rules tighten Central quote system installed to provide instantaneous bid-ask prices by phone. Markets crash of 1929. High speed black box ticker introduced. Dow reaches bottom, 89% below 1929 peak.

T, R, S R

1844 1866

T T

1871 1878 1881 1899 1903 1906 1907 1911

T T T R T S R

70 55 25 77 55

15 30 52 22 10 57 26

1913 1914 1918

R S T,S

45 102 76

1920 1923

T R,S

80 57

4 23 7 8 5 97

1926 1929

R T,S

50 58

1930 1932

T S

53 150

(continued overleaf )

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TABLE 15.1 (Continued)

Spreads(BP) from Jones (2002) 95 92 Change in Spreads 55 3 27 12

Year 1933 1934

Description The Securities Act of 1933. The Securities Exchange Act of 1934 establishes Securities and Exchange Commission (SEC). World War II ends with Allied victory. NYSE permits member rms to incorporate, giving them greater access to capital. Volumes consistently exceed 1 million shares daily. Listed companies urged to include outside directors on boards. Ebasco service report suggests automating the trading oor with respect to transaction reporting and improved stock clearing and quotation service. NYSE discourages trading by company insiders. 900 Ticker System with twice the speed replaces the Black Box system. Transmission of trade and quote data from the oor is fully automated. Radio paging begins. Congress creates Securities Investor Protection Corporation to protect customers of failed brokerage rms. Central certicate service is established to transfer securities electronically. surging volumes precipitate paperwork crisis. Securities Industry Automation Corporation Established. Oil embargo cripples markets worldwide. Fixed commissions abolished. Automated designated order turnaround (DOT) system is introduced to electronically route smaller orders. Intermarket trading system launches providing electronic link between NYSE and competing exchanges, enabling brokers access to all markets. Launch of Super DOT 250 an electronic order-routing system that links member rms to specialist posts on the trading oor. Dow loses 22.61 percent on October 19, largest one day drop.

T, R, S R R

1945 1953

S R,S

65 77

1956 1957

R T

70 65

7 5

1959 1964 1966

R T T,R

63 45 55

2 18 10

1968

55

1972 1973 1975 1976

T S R T

60 70 77 50

5 10 7 27 5

1978

45

1984

41

1987

57

16

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TABLE 15.1 (Continued)

Spreads(BP) from Jones (2002) 48 Change in Spreads 9

Year 1988

Description Circuit breakers installed to coordinate procedures between NYSE and Chicago Mercantile Exchange to control extreme price movements and share surveillance data. Off-hours trading until 5:15 p.m. introduced Integrated technology plan is begun to enhance trading oor networks to handle over 1 billion shares per day. Trading post upgrades to include handheld terminals, ber optics, and cellular communications. First large-scale application of high-denition at-screen video technology is installed to speed market information and strengthen trading oor professionals ability to manage orders. Real time ticker available to all investors on CNBC and CNN-FN. Trading in sixteenths tick-size. wireless data system installed to allow brokers to receive, access, and transmit market information and trades from anywhere on trading oor. NYSE requires domestic listed companies to seat at least three independent directors. NYSE unveils 3D trading oor, an advanced trading oor operations center. DJIA tops 10,000 for the rst time. NYSE Direct + provides immediate automatic execution of limit orders up to 1,099 shares at NYSE quote. Decimal tick size trading begins. DJIA Index sees it biggest one day point rise and a month later biggest point decline. Complete transition to Decimal Trading. 9/11 Terrorist attacks. NYSE OpenBook launches, a new market information product that provides off-oor market participants a view of the buy and sell interest in all NYSE-listed securities beyond the best bid and offer. The Sarbanes-Oxley Act, which aims to protect investors by improving the accuracy and reliability of corporate disclosures, goes into effect.

T, R, S T

1991 1993

T T

45 35

3 10 5 4

1994

30

1995

26

1996 1997

T R,T

20 16

6 4

1999

R,T,S

15

2000

T,R,S

19

2001 2002

R,S T,R

11 10

8 1

(continued overleaf )

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TABLE 15.1 (Continued)

STOCK MARKET LIQUIDITY

Year 2003

Description NYSE Liquidity Quote launches in a 28-stock pilot, disseminating executable, sizable quotes outside of the best bid or offer. Investors and market professionals can use this product to nd greater market size and depth. SEC approves the NYSEs new corporate governance standards for listed companies, requiring boards of NYSE-listed companies to have a majority of independent directors. NYSE expands Direct + system signicantly increasing the level of purely electronic trading. NYSE and ArcaEx Agree to merge.

T, R, S T,R

Spreads(BP) from Jones (2002) 7

Change in Spreads 3

2004

2 1

2005

using our own calculations from the TAQ dataset. In the rst column, Table 15.1 contains all the years with at least one major technological advancement, regulation, market sentiment, or scandal. The description of these major events is in the next column. The third column identies the nature of event. Liquidity level is presented in the fourth column. The last column is the change in spread. A negative number indicates a spread lowering or liquidity improving event whereas a positive number represents deterioration in liquidity. It is evident from Table 15.1 that technological and regulatory advancements have ensured a secular decline in spreads over the last century. Spreads were 70 basis points in 1900 and fell to 4 basis points in 2005. Nevertheless, markets have been subjected to liquidity deteriorating nancial shocks and scandals from time to time. For example, the Great Depression of 19291932 sent the spreads all the way up to 150 basis points. We now discuss the effects of some of the more important events on liquidity. Optimism among investors results in high price levels and reduces proportionate spreads because of the denominator effect. Proportionate spreads declined by 30 basis points in 1906 when Dow Jones set a record to close above 100 points for the rst time. Soon after, however, nancial problems at Knickerbocker Trust triggered a run on banks in 1907. There was a negative impact on liquidity with spreads increasing by 52 basis points. Subsequent regulation of issuers, brokers, and bankers ameliorated the situation a bit. In 1914, World War I resulted in a prolonged closure of the markets. When markets nally opened, the average spreads were 57 basis points higher. The emergence of United States as a creditor nation and investment capital of the world after the war, expanded pneumatic tube technology in 1918, the establishment of Fraud Bureau in 1923, and the start of a bull market all resulted in a substantial decline in spreads. Extreme pessimism and record volatility experienced after the great depression completely reversed the liquidity improving phenomenon

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and increased spreads by a whopping 97 basis points in 1932. The Securities Act of 1933, lead to a 55 basis point reduction in spreads and proved to be a boon for the ailing nancial markets. Allied victory in World War II in 1945 led to further reductions in spreads. Technological improvements in the form of the 900 Ticker System in 1966, automated Designated Order Turnaround (DOT) system in 1976, and integrated technology plan of 1993, all led to double-digit basis point reductions in spreads. Further developments include the trading post upgrades of 1994 to include handheld terminals, ber optics, and cellular communications; high-denition at-screen video technology installed to speed market information in 1995; real time ticker on CNBC and CNN-FN in 1996; tick-size reductions to sixteenths in 1997; 3D trading oor in 1999; NYSE Direct+ that provides immediate automatic execution of limit orders in 2000; decimal tick-size trading in 2001; NYSE OpenBook launch in 2002 that provides off-oor market participants a view of the buy and sell interest in all NYSE-listed securities beyond the best bid and offer; and the NYSE LiquidityQuote disseminating executable, sizable quotes outside of the best bid or offer in 2003. All these developments have squeezed the spreads down to 4 basis points in 2005. Such dramatic reductions in spreads help reduce the cost of capital because investors demand a lower equity premium for more liquid nancial securities (Amihud and Mendelson, 1986). Thus, liquidity can indirectly have far reaching effects on capital formation and economic growth in a country.

15.2
15.2.1

EVOLUTION OF TRADING TECHNOLOGIES

Floor Trading

Floor trading was the basis for most, if not all early exchanges. Buyers, sellers and speculators would gather in a predetermined place and time to trade securities. Prices were negotiated and recorded manually. A oor trade follows a few simple steps. First, a customer places a trade with his broker, giving him specic instructions such as buying 1,000 shares of a stock at market or a limit price. Next, the broker communicates the order to their trading oor. The oor broker will then nd another broker wishing to sell 1,000 shares at the current market price or the limit price. The sale is then complete and the status of the order execution is communicated to the customers. The typical methods used in oor trading are open outcry or call auctions. Today, as in the past, oor traders function as ballast for exchanges, providing liquidity when it is dry. Trades executed using the oor method are taken, handled and executed by humans, leading to trading errors, and trading inefciencies. Conversely, computer trading is void of any above-mentioned errors, but has its own caveats.

15.2.2

Computer Technology

The most dramatic tool introduced to the trading oor in the last century may be the computer and related products/innovations. Computer technology has had a dramatic effect on trading volumes, efciencies and helped create a whole new arena of investors and traders. Trading volumes were no longer restricted to how

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many hands were trading or documenting trades, but computer technology allowed volume to be determined by investors trading appetite. The efciency computers brought to the exchanges geometrically increased the number of shares traded on a daily basis, the number of investors in the markets and also the amount and accuracy of information available to investors and researchers. Shortly after trading was computerized, trading volumes leaped, liquidity increased, and the number of investors ballooned. It is possible for a case to be made that the computer put in motion the equity bubble of the 1990s because so many new entrants were brought to the market in such a short period of time. Precomputer, the oor-trading-only model could simply not handle the inux of new money and investors to the market. Internet technology has also revolutionized the way investors participate in the market. To be a market participant now only requires a computer and Internet connection. The benets to this advancement are clear. Investors have almost unlimited access to trading information, ability to execute almost any trade in an instant and move money around the world at the press of a button. Only 20 years ago, these abilities were reserved for only the largest banking and investment companies. Table 15.2 compares the salient characteristics of oor trading with those of electronic trading. Most of the features of electronic trading offer considerable ` benets to investors and traders, vis-a-vis oor trading environment. Jain (2005) reports a strong trend towards full automation of trading for the leading exchange in almost every country of the world. Although the technological innovations took place in the United States in 1969, their commercialization initially affected only the institutional trading platforms such as the Instinet. In fact, the Toronto Stock Exchange took the lead in 1977 when it adopted screen-based trading. The Paris Bourse is another leading exchange that automated and then designed systems which were subsequently sold to several exchanges around the world. The NYSE, the leading U.S. exchange, introduced the facility of fully automated

TABLE 15.2 Floor Trading Versus Electronic Trading

Characteristic Trader identity Order ow transparency Quote transparency Quote life Floor Trading Face to face trading results in reputation building. Order ow is hidden. Best quotes only are known. Quotes evaporate and good only until the breath is warm. Slower order transmission and trade execution Slower settlement Higher operating cost Higher transaction cost Expensive remote access Reliance on single/few market makers Electronic Trading Trader identity can be hidden or displayed. Order ow is displayed. All quotes can be displayed. Quotes are rm until withdrawn or consumed. Almost instantaneous execution of trades Faster settlement Cheaper Deeply discounted brokerage Better accessibility Competition from numerous value trades

Trading speed Settlement Exchange viability Transaction costs Remote access Competition among liquidity suppliers

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trade execution, known as Direct+, only very recently in December 2000 although electronic routing of orders on SuperDOT has been in place since 1985. Today, the leading exchange in 101 of the 120 sample countries in Jain (2005) has electronic trading. Of these 101 exchanges, 85 are fully electronic, with no oor trading.

15.2.3

Remote Accessibility

Traders from all over the world now have access to and can act on quote and trade information at the same instant as if they if they were standing on the oor of the exchange. Conceptually, the trading post has extended as far as the internet can reach. Internet technology has enabled traders from around the world to participate in markets that best ts their needs and preferences, sparking competition among the different markets. With communication networks extended all over the globe, traders anywhere can investigate and exploit arbitrage opportunities, no longer bound by their location. New pools of liquidity are thus becoming available in the secondary market.

15.2.4

Demutualization and Expansion of Membership

In the past, the ability to trade on a particular exchange was usually controlled by few members who owned a seat on the exchange. Typically, these members mutually owned the exchange and would not let the membership expand easily. This greatly restricted the access and forced investors to buy and sell through a small set of traders, creating a bottleneck in the trading process. The modern era of the stock exchange industry has another dening feature, namely, the demutualization of ownership of the exchange. This involves the separation of ownership and trading rights. Demutualization frees the exchange management from vested interests of trading members and gives ready access to vast amounts of capital. However, a for-prot structure can create conict of interests between shareholders who own the exchange and regulators who are interested in public welfare. Nevertheless, if it is optimal to expand the number of members with trading rights, the shareholders of a demutualized exchange will be more willing to implement policies along those lines. The Stockholm stock exchange was the rst to demutualize in 1993. Most other leading exchanges have followed suit with NYSE being the most recent one in 2006.

15.2.5

Network Effects and Competition

The network effect can be explained by a basic example of fax machines. What is the worth of having only one fax machine in the world? Nothing. But a network of 10 faxes is worth something, and increasing the number of faxes only increases the worth of each machine in the system. This is true for exchanges too. An exchange without another buyer or seller is not worth anything, but as the number of participants in the market increases, the value of the exchange increases. Adoption of trading technologies has greatly increased the number of possible investors in any given market. With the help of technology, nearly anyone in the world has the ability to invest in any developed stock exchange in the world thereby increasing the number of possible investors immensely. As the developing world continues to update and modernize their trading technologies and procedures, the number

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of potential investors will also increase. Exchanges have become aware of this development and have been competing to become the market providing highest-level of liquidity possible for both buyers and sellers.

15.3

GLOBAL PERSPECTIVES

Security exchanges operate in every corner of the globe, intersecting all legal, ethical, and business cultures of the world. Such differences in nancial environment imply varying results when technology is adapted on different exchanges. In this section, we examine different results on trading and liquidity when new technologies are introduced around the world on 71 different exchanges. Using data from Jain (2005), we investigate how oor automation has changed the trading characteristics around the globe. As with most technological advancements, we expect to see observable differences between countries to have varied reactions to the introduction of automated trading. On an average, automation has provided exchanges with not only an increase in liquidity but also a drastic reduction in cost of capital. For all 71 countries used in Jain (2005), average liquidity increased by 3 percent and cost of capital was lowered by 1.2 percent. After automation 71 percent of exchanges experienced a positive change in liquidity and 80 percent of the countries improved their cost of capital. Table 15.3 gives the breakdown of positive and negative inuences of automation. Although the effects of automation are largely positive, not every country has experienced the same level of liquidity improvement or cost-of-capital reduction. In Table 15.4, we explore various determinants of the magnitude of effects of automation. Panel A of the table categorizes the sample countries from Jain (2005) into various regions of the world. The liquidity effects of automation are the strongest in Europe, where liquidity improved by 6.69 percent followed by Africa and Asia. They are the mildest in South America where liquidity is actually somewhat worse in electronic trading environment although the region leads in the cost of

TABLE 15.3 Automation Affects Liquidity and Cost of Capital Around the Globe
Change in Liquidity Average Response to Automation: Entire Sample Number of exchanges with positive change Average change in positive countries Number of countries with negative change Average change in negative countries 3.02% 47 5.70% 19 3.63% Change in Cost of Capital 1.23% 14 0.79% 57 1.73%

Note: Turnover data is provided for 66 countries and cost of capital for 71 countries by Jain (2005). Changes are calculated by subtracting the level of liquidity or cost of capital before automation from their respective levels after automation.

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TABLE 15.4 Determinants of the Effects of Automation

Panel A: Regions of the World Region Americas Africa Asia/Pacic Europe Middle East South America Liquidity Improvement 0.89% 3.06% 1.23% 6.69% 0.99% 0.92% Cost of Capital Reduction 0.71% 1.93% 0.85% 0.73% 1.67% 2.33%

Panel B: Economic Development and Effects of Automation Liquidity Developed countries Emerging markets 5.90% 1.58% Cost of Capital 0.28% 1.68%

Panel C: Laws Prohibiting Insider Trading and Their Enforcement Liquidity Laws prohibiting insider trading do not exist Insider trading is prohibited by law Actual prosecutions have been successfully undertaken against violators Panel D: Shareholder Rights Index Liquidity 5 (best) 4 3 2 1 (least) Panel E: Partial or Full Automation Liquidity Full Partial 3.26% 1.81% Cost of Capital 1.17% 1.58% 5.64% 6.23% 3.52% 3.36% 0.90% Cost of Capital 0.75% 1.11% 0.94% 0.79% 0.71% 1.99% 3.52% 3.59% Cost of Capital 3.00% 1.01% 0.96%

capital benets of automation. Panel B of Table 15.4 differentiates the sample countries by their level of economic development according to Morgan Stanley Capital International classication scheme. Here we can see that automation helps increase the liquidity more in developed countries but liquidity also improves in emerging markets. Preautomation cost of capital is very high in emerging markets

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and they see a bigger impact of automation in lowering the cost of capital for listed companies. Next we look at the legal environment in each country to assess its interaction with the role of automation. Specically, in Panel C of Table 15.4, we ask the question whether a country has laws that prohibit insider trading laws. It is also important to note whether the laws are actually enforced in practice because corruption and lax enforcement can defeat the purpose of any law. Although the United States has the reputation of putting people with celebrity status behind the bars for insider trading violations (e.g., Martha Stewart case), in many other countries traders freely trade on insider information without much fear of prosecution. Data for existence and enforcement trading laws is obtained from Bhattacharya and Daouk (2002). Our analysis shows that a sound legal system is necessary for the liquidity effects of automation to materialize. Liquidity improves by over 3 percent after automation if insider trading is banned. Enforcements amplify the liquidity effects of automation. In contrast, automation hurts liquidity in the absence if insider trading laws. Nevertheless, automation has a positive role in reducing the cost of capital irrespective of the legal situation. Continuing on with the analysis of legal environment, in Panel D of Table 15.4, we categorize the sample countries based on a shareholders rights index created by La Porta et al. (1998). The index scales from 0 to 5 with zero representing no rights and 5 representing most rights for public shareholders. The impact of automation on both liquidity and cost of capital generally increases with the degree of protection provided to the shareholders by law. Finally, we examine the differences between full and partial automation. Some exchanges, such as the Paris Bourse, entirely rely on electronic trading and abolish the trading oors whereas others, such as the NYSE, partially automate trading and retain their trading oors. Panel E of Table 15.4 shows that liquidity improves substantially even with partial automation but full automation has almost twice the impact. Cost of capital benets are obtained with full or partial automation.

15.3.1

Limitations of Technology

Every technological advancement from the telegraph to the Internet has had tremendous positive effects on market liquidity and increased the number of investors who participated on the exchanges. Along with these benets, however, there are some dangerous episodes and painful consequences from these advancements. In the last 20 years, two major market disruptions were facilitated due to technology intended to increase liquidity, but for a short time, actually had the opposite effect. The rst event being the 1987 market crash, where program trades intended to protect investors from large losses actually caused investors huge losses and specialists, who are supposed to provide liquidity, failed in that duty.1 Precisely when liquidity was needed, it dried up and with no buyers, the market had nowhere to go but down. Since then, new measures and procedures have been implemented to avoid a similar crisis. Since 1987, the U.S. exchanges have in fact weathered much more serious events without full-scale market selloffs. The second event was the Asian contagion in 1997, where liquidity, which was created by connecting traders from all over the world in far-ung trading networks,

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was almost instantly withdrawn, causing major market dislocations that can still be felt and observed in some affected countries today. Leading up to 1997, developing economies in the Asia-Pacic region beneted greatly from the extension of traders ability to place trades anywhere in the world. Foreign capital owed in countries such and Thailand, South Korea, and Indonesia at unprecedented rates. Flush with the new investments, businesses ourished in these countriesit was like a marriage made in heaven. This situation continued until the situation entered a dangerous tipping point, when foreign investors started withdrawing their funds, in effect, closing off liquidity in the system. The ramications of this were tragic for the Asian economies that became dependent on the liquidity provided by foreign investors. Without the newfound inow of foreign money, their economies sank and required emergency actions to fend off nancial disaster. Technology has some other minor limitations too. Over reliance on computers means that if the system malfunctions for any technical reason, then trading has to stop. Such teething problems usually disappear after a few occurrences as solutions and alternatives to address the problems are developed. Longer trading hours and speedier execution also mean that stock prices demonstrate lot more volatility today. However, this is more a reection of the fact that with automation we can accomplish volumes of trading within seconds that would have taken years in the past.

15.4 FUTURE ADOPTION OF TECHNOLOGY AND POSSIBLE IMPLICATIONS

New technologies come with greater responsibilities. The most recent trading technology, which increased market liquidity, is the wide-ranging use of nancial derivative products. Some have predicted, including Warren Buffett, that derivatives will have as great or greater negative consequences on the markets in the near future as any other advancement to the market. Regardless of what causes the next liquidity crises or when it happens, the market will most likely rebound and investors will discount and readjust to the new risks the excess liquidity has provided the market. Gone forever are the days of the original exchanges where traders waited to trade one stock at a time. Now traders, investors, and companies benet from the exchanges ability to deliver an ever increasing array of nancial products throughout the world24 hours a day and nearly 365 days a year. Recent technology innovations have created markets today that would appear foreign to traders only a few decades ago. The adaptation of new technology to the exchanges will continue to improve market operations and liquidity levels in ways that may be unimaginable today. The liquidity we observe today could not have been dreamed of years ago because the technology did not exist. Increased global competition and global consolidation is likely to be the order of the stock exchange industry in near term future. The trend of exponential growth in volumes will only accelerate as multitudes of new investors engage in cross border investment activity. Increased liquidity will make it easier and more rewarding for equity researchers to trade. It will not be too perilous to predict that further technological advancements will result a healthy and thriving stock markets in the world.

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REFERENCES
Amihud, Y., and Mendelson, H. (1986). Asset Pricing and the Bid-Ask Spread. Journal of Financial Economics, 15(12):223249. Bhattacharya, U., and Daouk, H. (2002). The World Price of Insider Trading. Journal of Finance, 57(11):75108. Jain, P. (2005). Financial Market Design and the Equity Premium: Electronic versus Floor Trading. Journal of Finance, 60(6):29552985. Jones, C. (2002). A Century of Stock Market Liquidity and Trading Costs. Working Paper, Columbia University. La Porta, R., Lopez-de-Silanes, F., Shleifer, A., and Vishny, R. (1998). Law and Finance. Journal of Political Economy, 106(6):11131150.