Discover the Nordic Market Quality database: Making financial markets research more feasible
Oct. 02, 2023
Professor Björn Hagströmer has prompted the development of the Nordic Market Quality database (NMQ). In this interview he explains why financial market microstructure research is important for shaping the future of financial markets, and how NMQ can provide masters students and other academics with exciting research and development opportunities in the field.
The world of stock trading has changed tremendously in the last two decades, with the blend of financial innovation, automation and regulation. While the pressure on regulators to manage these developments is mounting, they lack the time and resources to process and analyse the massive amounts of data which are produced by the mix of fast and slow traders across the globe on a normal day. This is generating a closer collaboration between regulators, the financial industry and academia, with increasing reliance on academia to provide clarity and insight through research.
Björn Hagströmer is a Professor of Finance and Director of Research Studies at Stockholm Business School at Stockholm University, and a visiting research fellow at the Swedish House of Finance. Conducting research on financial market microstructure, with applications to asset pricing, financial ecometrics and liquidity measurement, Professor Hagströmer tells us that what these metrics ultimately aim to measure, is the quality of the market.
Why market quality is an important measure
“A high-quality market is one where it is easy to find a trading counterparty, and where you can trade at a price that is close to the true value. Market quality can be measured in terms of liquidity and efficiency. While market liquidity captures transaction costs, broadly defined, market efficiency indicates how representative market prices are for the true value of the security.
In an efficient market, the value of the security is the same as the price. But markets are not always efficient. They can be efficient to different degrees. In this field of research, we are interested in the deviations from market efficiency. How much do the prices deviate from the true value? How fast does the price converge to the true value?”
Professor Hagströmer elaborates further. “In the field of financial market microstructure, we do not focus on what stocks to buy, or how to allocate the assets in a portfolio. Instead, we are interested in the infrastructure that facilitates the trading. I.e., how do buyers and sellers find each other? How do prices converge to the true value of the security? How do these trading systems handle market volatility or market stress? In times of crisis, do the systems still work, or does the price volatility spill over to operational volatility? If there is too much activity, will the systems crash?”
“At a general level, it’s crucial to understand that not all markets are the same, stock markets are organized differently from bond markets, and they are also different from derivative markets. The market structure is the product of financial innovation and regulation, in combination with market traditions. In order to understand the whole, you need to understand the details. Financial market microstructure is about the details, and it’s the details that makes this field so exciting.”
Making research with rich data more feasible
Professor Hagströmer was therefore very excited to discover the SHoF’s Nasdaq HFT (High Frequency Trading) database. “The material that Nasdaq Nordic has been donating to the Swedish House of Finance’s (SHoF) data center for the past ten years is incredibly rich. It includes every quote and every trade, resulting in millions of observations. The downside, however, is the dauting task of managing the huge amounts of data. The sheer mass of information is a barrier to entry for this type of research, and we needed to find a way to overcome that.”
That gave him the idea to develop the Nordic Market Quality (NMQ) database in collaboration with the SHoF Datacenter as a way to provide students and researchers with access to more manageable information. “We thought, why not pre-calculate the most common market quality measures for the research and student community? So, today, the NMQ database offers data on the stock-day frequency, meaning that for every stock that is traded at Nasdaq Nordic, you can get a set of measures of market quality for each day.”
What’s unique about SHoF’s Nasdaq HFT data?
What is unique about SHoF’s Nasdaq HFT database, says Hagströmer, is that you have access to the full limit order book. “Most other databases are restricted to information about the best prices, but that is only the tip of the iceberg. In SHoF’s Nasdaq HFT Database, researchers can see all individual orders, regardless of price levels, and they can do so for a large set of stocks over a fairly long period of time. The ability to track orders everywhere in the limit order book opens up for a micro-level approach to research questions that are otherwise tackled using aggregate measures.”
Another advantage of studying Nasdaq Nordic’s data-sets in particular, he says, is that for long periods of time the trade records have come with identifiers of the financial institution behind the trade. In other words, you can see who has been trading with whom. “It is a feature that not many other markets have had.”
A limitation to SHoF’s Nasdaq HFT Database, and by extension NMQ, however, is that while modern equity markets are highly fragmented, these databases cover trading at Nasdaq Nordic only. The implication is that trading at other platforms is not included. For small stocks, Nasdaq Nordic has virtually all trading activity, but for large-caps around half of the trading activity takes place elsewhere. Depending on the research question, this limitation is important to keep in mind, he continues.
So, what if you need to obtain the full set of Nordic large-cap trading activity for your research? Hagströmer explains that at Stockholm University, for example, they subscribe to a database called Tick History. Although it does not include the full limit order books, it allows you to see trades and quotes relating to Nordic companies from competing trading venues.
Award-winning studies that draw on SHoF Nasdaq HFT data
Professor Hagströmer reveals that several of his masters-students have made use of the SHoF Nasdaq HFT Database to conduct empirical studies on the Swedish stock market for their research. The one below won the Swedish House of Finance’s Master Thesis award in 2021:
In this study Jesper Andersson and Alexander Hübbert examined whether the tick size regime on systematic internalisers (SIs) altered the market composition of trading venues and impacted the market quality at Nasdaq Stockholm in the course of 2020.
Leveraging data from Nasdaq HFT and the Finbas database via the Swedish House of Finance’s National Data Center, the research results established that striving for an equivalent playing field for trading venues and SIs causes a negative spill-over effect. In particular, the study identified that enforcing the MiFID II tick size regime on SIs caused a decrease in market quality for the trading venues involved.
The runner-up for the 2021 Master Thesis award went to “Post-MiFID II: Dark Pool Bans and Regulatory Effects on Lit Market Quality", conducted by Isak Djudja & Hugo Hammar from the University of Gothenburg. They also used SHoF Nasdaq HFT data as part of their research.
Themes to boost future research using NMQ
While the new Nordic Market Quality database is designed to make financial market microstructure research less arduous to masters-students going forward, the devil will still be very much in the detail, confirms Professor Hagströmer.
Considering themes suitable for the NMQ database, these are some of his suggestions:
How does financial regulation influence market quality?
In market microstructure, this is a classic type of research question. Whenever the rules of the game change, it influences trading strategies and investment decisions, and ultimately the quality of the market. With NMQ, the market quality measures are easily available.
How does market quality influence trading decisions and asset prices?
Whereas the question above has market quality as the outcome variable, it can also be studied as a determinant of trading and investment behavior. Examples of research questions include how liquidity influences the portfolio allocations, for example in passive and active mutual funds? How are the portfolios reallocated in times of crisis? How do changes in liquidity influence stock prices? Do retail investors consider market quality when making their trading decisions?
How do corporate events affect market quality?
Another area of interest is the relation between market quality and corporate events. For example, does the merger of two firms lead to better liquidity? Or, if you turn it around, if there is a merger, do stocks with different liquidity react differently to this piece of news?
Moving beyond “the efficient market hypothesis”
“As a researcher, I think financial market microstructure is an excellent field to study in order to understand how markets actually work, and what the limitations to the efficient market hypothesis are,” says Professor Hagströmer.
He concludes by highlighting the active and growing exchange between academia and industry, simply because regulators cannot rely on their gut feeling alone. “It is really hard to be able to judge the consequences in today’s trading environment without deeper insight into the underlying mechanics. Academics have the resources and the patience to analyze the complex trading environment that we have today. That allows us to play an increasingly important role for shaping the financial markets of the future.”