96838 - MICROECONOMIC FOUNDATIONS OF FINANCIAL MARKETS

Learning outcomes

This course teaches the theory of financial market microstructure, that is how asset prices are formed as a direct result of explicit trading rules. It also analyzes how different regulatory settings impact on the dynamic price mechanisms. A special attention is devoted to trading systems on stock exchanges and other financial markets. The role of algorithmic trading is explicitly taken into account in the light of the recent regulatory evolution. At the end of the course, students understand the determinants of transaction costs and the dynamics of prices, quotes and volumes.

Course contents

The course aims to provide students with the basic knowledge about microstructure concepts. The focus is on both institutional details (the organization of the most important financial markets) and on technical aspects.

In general, our goal is to analyze the characteristics of market and trade behavior, taking into specific account the impact of new technologies on market structure and microstructure. We examine the interaction of technology and regulation and its effect on market structure and on traders' behavior.

Specifically, we analyze the role of investors, brokers, dealers, arbitrageurs, retail traders, buy-side traders, day traders, rogue traders and gamblers. We study the different types of orders: limit orders, market orders, stop orders. Some aspects related with insider trading, front running and market manipulation are also explored, together with the recent phenomena of dark pools. Special attention will be dedicated to High Frequency Trading and Algo Trading, Optimal Execution Strategies, and the use of AI, given their massive importance in the recent evolution of financial markets.

Readings/Bibliography

The primary textbook references are:

1. Thierry Foucault, Marco Pagano, Ailsa Roell, "Market Liquidity: Theory, Evidence, and Policy", Oxford University Press, 2013. (FPR 2013 - selected chapters)

2. John C. Hull, "Options, Futures and Other Derivatives", 10th ed., Pearson, 2018 (H2018 - selected chapters)

We might also use material from the following sources:

Frank de Jong and Barbara Rindi, "The microstructure of financial markets", Cambridge University Press, 2009. (dJR 2009)

Joel Hasbrouck, "Empirical Microstructure Models", Oxford University Press, 2007 (H2007)

Other material:

Lecture notes

Additional references may be provided during the course.

Teaching methods

Each class is organised in two distinct part: in the first part an overview of the topic is given by the instructor. In the second part there will be active class discussion.

Class participation is crucial. A detailed schedule with lesson by lesson reading assignments will be provided at the beginning of the course. Students are expected to read the material and participate to the class discussion.

Assessment methods

Students attending lectures

Students are considered attending students if they participate in at least 80% of the lectures.

1. Class presentation (20 min. - counting for 50% of the final grade), assessing the ability to manage and apply the methods and knowledge absorbed during the entire course. Topics for the paper will be delivered during the second week of the course. Students will present their papers in class during the last two lectures. They are strongly encouraged to work in groups of min 2 and max 4 people.

2. Written exam (counting for 50% of the final grade).

The written examination is closed-book and lasts 1 hour and 15 minutes. It tests the theoretical and analytical knowledge acquired throughout the course.

The examination consists of:

• one open question, chosen from two available questions, worth a maximum of 16 points;
• four multiple-choice questions requiring a theoretically grounded justification, worth a maximum of 4 points each.

The examination is worth a maximum of 32 points.

Excellence: 16 points
The answer is exhaustive, correct, and complete, demonstrates excellent analytical ability, and uses technical terminology accurately and effectively.

Very good performance: 14–15 points
The answer is correct, comprehensive, and complete, and demonstrates very good critical and analytical ability.

Good performance: 11–13 points
The answer is correct and substantially complete, and demonstrates a good level of critical analysis and an appropriate use of technical terminology.

Sufficiency: 9–10 points
The answer is broadly correct and demonstrates a satisfactory ability to analyze the topic. Technical terminology is mostly used correctly.

Insufficiency: 6–8 points
The answer is only partially correct, lacks completeness or depth, and demonstrates limited critical analysis. Explanations may be superficial, connections between concepts may be weak, and technical terminology may be incorrect or inconsistent.

Failure: 0–5 points
The answer is largely incorrect, incomplete, lacking essential elements, or off-topic.

In the multiple-choice questions, students must select an answer and justify their choice on the basis of the relevant theory. The evaluation considers the correctness of the selected answer, the quality of the justification, and the use of appropriate technical terminology.

Excellence: 4 points
The selected answer is correct, and the justification demonstrates an excellent understanding of the relevant theory and a precise use of technical terminology.

Good performance: 3 points
The selected answer is correct, and the justification demonstrates a very good understanding of the relevant theory, with only minor omissions or errors. Technical terminology is mostly correct.

Sufficiency: 2 points
The selected answer is correct, and the justification demonstrates an adequate understanding of the relevant theory, although it may not be exhaustive. Technical terminology is generally appropriate.

Insufficiency: 1 point
The selected answer is incorrect, but the justification demonstrates some understanding of the relevant theory.

Failure: 0 points
The selected answer is incorrect, and the justification demonstrates minimal or no understanding of the relevant theory.

Students obtaining more than 30 points in the overall weighted grade will receive a final grade of 30 cum laude.

Students not attending lectures

Written examination: 100% of the final grade

The written examination is closed-book and lasts two hours. It assesses the theoretical and analytical knowledge acquired through the study of the course materials.

The examination consists of:

• two open questions, worth a maximum of 8 points each;
• eight multiple-choice questions requiring a theoretically grounded justification, worth a maximum of 2 points each.

The examination is worth a maximum of 32 points.

Open questions

In their answers to the open questions, students must demonstrate mastery of the relevant topics, an ability to perform critical analysis, and an appropriate use of technical terminology.

Excellence: 8 points

The answer is exhaustive, correct, and complete, demonstrates excellent analytical ability, and uses technical terminology accurately and effectively.

Very good performance: 7–7.5 points

The answer is correct, comprehensive, and complete, and demonstrates very good critical and analytical ability.

Good performance: 5.5–6.5 points

The answer is correct and substantially complete, and demonstrates a good level of critical analysis and an appropriate use of technical terminology.

Sufficiency: 4.5–5 points

The answer is broadly correct and demonstrates a satisfactory ability to analyze the topic. Technical terminology is mostly used correctly.

Insufficiency: 3–4 points

The answer is only partially correct, lacks completeness or depth, and demonstrates limited critical analysis. Explanations may be superficial, connections between concepts may be weak, and technical terminology may be incorrect or inconsistent.

Failure: 0–2.5 points

The answer is largely incorrect, incomplete, lacking essential elements, or off-topic.

Multiple-choice questions

For each multiple-choice question, students must select an answer and justify their choice on the basis of the relevant theory. The evaluation considers the correctness of the selected answer, the quality of the justification, and the use of appropriate technical terminology.

Excellence: 2 points

The selected answer is correct, and the justification demonstrates an excellent understanding of the relevant theory and a precise use of technical terminology.

Good performance: 1.5 points

The selected answer is correct, and the justification demonstrates a very good understanding of the relevant theory, with only minor omissions or errors. Technical terminology is mostly correct.

Sufficiency: 1 point

The selected answer is correct, and the justification demonstrates an adequate understanding of the relevant theory, although it may not be exhaustive. Technical terminology is generally appropriate.

Insufficiency: 0.5 points

The selected answer is incorrect, but the justification demonstrates some understanding of the relevant theory.

Failure: 0 points

The selected answer is incorrect, and the justification demonstrates minimal or no understanding of the relevant theory.

Students obtaining more than 30 points in the examination will receive a final grade of 30 cum laude.

Use of Artificial Intelligence in Assessment

Paper for attending students

A limited, declared, and non-substantive use of artificial intelligence tools is permitted exclusively for support activities, such as language revision, the rephrasing of content already developed by the students, the summarization of notes or course materials, and the formal review of the text.

Artificial intelligence tools may not be used to develop the argument, carry out the economic analysis, interpret sources, formulate evaluations or conclusions, or generate, either in whole or in part, substantive sections of the paper. The submitted work must therefore reflect the students’ own knowledge, analytical skills, and independent reasoning.

Any use of artificial intelligence must be disclosed, specifying the tool used and the tasks for which it was employed. Students remain fully responsible for the accuracy, quality, and originality of the submitted work.

Written examination

The use of artificial intelligence tools, as well as any other tools or materials not expressly authorized, is not permitted during the examination. Any such use constitutes a breach of academic integrity and will be handled in accordance with the relevant University regulations.

Teaching tools

https://virtuale.unibo.it/

Links to further information

https://virtuale.unibo.it/

Office hours

See the website of Emanuela Carbonara