The New Stock Market: Law, Economics, and Policy

Merritt B. Fox is the Michael E. Patterson Professor of Law at Columbia Law School; Lawrence R. Glosten is the S. Sloan Colt Professor of Banking and International Finance at Columbia Business School; and Gabriel Rauterberg is Assistant Professor of Law at the University of Michigan Law School. This post is based on the introduction to their recent book The New Stock Market: Law, Economics, and Policy.

Markets for trading financial instruments are a central feature of modern finance and play a crucial role in the larger economy. The U.S. stock market, where public equities are traded, is a global symbol of commerce and trade. Its total valuation is about $25 trillion—almost double the total assets held by the commercial banking system. It serves as a principal vehicle for the direct and indirect investment of public savings, and represents roughly half of the value of the dollar savings of individual Americans. Its functioning is also critical to the process by which changes of control in major companies take place. The prices in the stock market incorporate enormous amounts of information and serve as important guides to decision making throughout the economy. Yet, despite their prominence, the stock market, and financial trading markets more broadly, remain deeply puzzling and complicated. The central institutions of the stock market are a series of trading venues—twelve stock exchanges, over thirty active alternative trading systems, and other forms of off-exchange trade—whose operational details and governing regulatory scheme are extremely complex. The stock market’s central economic dynamics, particularly the adverse selection dynamics created by informed traders, mark it off by degree, if not kind, from the ordinary markets of the real economy. And its controversies are both perennial and new. Insider trading, manipulation, and short-selling remain attention-grabbing, while newer participants and institutions, such as high-frequency traders and dark pools also generate discussion and debate.

In our just-published book, The New Stock Market: Law, Economics, and Policy, we aim to provide an accessible yet sophisticated overview of the institutions, social functions, and economics of the modern stock market, while illuminating how financial trading markets work more broadly. This is done with the principal ambition of understanding and improving the regulation of this market. Our book has two audiences in mind, and thus its ambitions are sometimes in tension. On the one hand, it aims to provide newcomers to the study of trading markets—whether regulators; industry professionals; interested laypersons; or law, economics, or business students—with an accessible overview of the major issues in these markets. On the other hand, it aims to generate novel, critical insights into a range of policy issues that even the seasoned scholar of these markets should find of interest. Thus, early chapters have an introductory character that the second audience may wish only to skim.

The book begins with chapters discussing the institutions, mechanics, and regulatory architecture of this market; the functions it serves for society; and the economic dynamics that underlie how it operates. The remainder of the book—parts II, III, and IV—generally adopts a normative approach, evaluating the practices of major participants in today’s equity markets and the structures in which they interact. A chapter on market structure focuses on the role of high-frequency traders in liquidity provision and controversies involving so-called “latency arbitrage.” Later chapters offer a broader welfare perspective on informed trading, before focusing on insider trading, manipulation, and short-selling. The last part of the book discusses broker-dealers, payment for order flow, and maker-taker fees, before concluding with a discussion of open issues in market structure.

Throughout the book, we keep to a central theme. Trading markets are distinguished not only by the assets traded in those markets, as is well-recognized, but by the informational structure of the market itself. Trading in the stock market is driven by pervasive information asymmetries, which leads to its distinctive dynamics and problems. We think this emphasis lends our book a unity of analysis, even as we range across a large number of issues and controversies. We hope it will prove a useful text for both students and scholars of trading markets and an accessible vehicle for a broader audience to better understand these fascinating institutions.

The full introduction is available for download here.

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