Abstract/Summary

This dissertation comprises four empirical essays on market quality. The first essay develops a reliable method for trader classification that identifies unique types of traders in the London Stock Exchange (LSE). We investigate the trading behaviour of high-frequency-traders (HFTs) and assess the impact of different styles of trading on liquidity and volatility. To achieve this, we utilise a comprehensive UK dataset covering two years of trade activity. We identify 76 HFTs, classified into four distinct sub-groups, and 51 registered market-makers actively trading in the LSE markets. The second essay investigates volatility in London’s Alternative Investment Market (AIM), the stock market for smaller and growing companies. Specifically, it provides new evidence comparing the relative riskiness of stocks trading on AIM to corresponding stocks trading on the Main Market, the flagship market of LSE for large-cap and blue-chip stocks. The purpose of this particular essay is to elucidate the perceived riskiness of AIM and measure the risk of comparable stocks on both markets. In this study, we test the hypothesis that AIM is inherently riskier than the Main Market, as stocks trading in small-cap/junior markets might be considered riskier than established stocks trading on primary exchange markets. The analysis of switchers indicates that the differences in volatility when stocks switched between AIM and the Main Market are extremely small, often not statistically significant, and tend – if anything – to exhibit a slightly lower volatility when a stock is listed on AIM. The third paper examines how trader participation is associated with liquidity. We find that although HFT activity does not harm liquidity as a whole, the evidence is mixed at the sub-group level. The final essay explores trader behaviour in periods of extreme short-term volatility and studies the effect of trader aggressiveness on liquidity. Few previous studies have answered research questions similar to the ones addressed in this study, which is the first to examine extreme short-term volatility in the LSE markets.