Financial Markets

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Problem 1
(a). Explain why it might be valuable for market makers to observe the order flow, and why this might be bad for traders.
The observation of the order flow allows market makers to comprehend the trend experienced by the traded securities. In essence, the value of the contribution associated order flow to market markers remains best attributed to the gains associated with the information. In the case of market markers, information that suggests possible gains in the pricing of the traded securities offers is to be treated with utmost importance. Assuming the trends in the order flow exposes the market markers to possible losses since they will be unable to predict the behavior of the buyers. In essence, such traits may be argued to be detrimental to the success of market markers when considering their role as security transaction (Hu, 627). Being unable to observe the order flow would imply being unable to buy the appropriate securities as well as inability to secure the orders considered favorable by the clients. In essence, the tracking of order flows allows appropriate pricing of securities to clients as well as the isolation of the ideal brokers upon which to engage in the respective transactions (Yuan, 552). Also, the adherence of the trends in order flow may be considered essential in cost cutting especially when considering the plight of small market markers.
The concept of market markers following order flow may be argued to be discriminatory to the interests of traders when the prospect of compensation is considered.

In essence, order flow reflects on the commissions associated with the execution of orders following a transaction. Most traders consider the commission associated with security trading as an elemental attribute of income (Edmans et al., 3768). Also, the details associated with order inflow allow the appreciation of the dynamics that define the market preference of securities due to the declarations associated with the process of order flow (Menkveld, 19). In essence, the concept of providing order flow may be argued as a disclosure on the trends of the buyers since it unveils the information that has been shared regarding the disposal or acquisition of securities. Therefore, the prospect of traders considering market markers paying substantial attention to the order flow trends may be argued to suggest reasonable concerns.
(b). In limit order books, traders choose themselves whether to provide liquidity (post limit orders) or to take liquidity (post market orders). Thus, in some sense, traders choose between being market makers and speculators, in the language of the Glosten/Milgrom model. What might affect their choice of becoming one or the other?
The Glosten-Milgrom model assists in deducing the transaction prices associated with the existing or introduced security competition. Limit order books are considered the markets for liquidity due to their unexecuted status. On expectation, the traders are anticipated to utilize the privileges associated with limit orders to balance the market. However, such action may lead to their characterization as market markers or speculators. Reflecting on the Glosten/Milgrom model, the quotation of a price is depended on the expectations associated with the buyers. Introducing arrival time as a variable in the pricing model allows the traders to be able to speculate on the action to be engaged on the unexecuted securities (Edmans et al., 3776). Considering the input of terms of prediction under the Glosten/Milgrom model, including the purported returns as well as the deviations to be shared towards the asking price, the need to participate in the trade may be limited to the expectations of the respective markers in comparison to the trends of the market.
The transition of traders to market makers and speculators may be further illustrated by the implication of the no regret scenario and the decision of the uninformed buyers. In essence, the valuation of the uninformed buyers tends to illustrate possible outliers to the mean of bids placed by the respective buyers (Menkveld, 17). There exists a possible challenge in the characterization of the expectations that are to be shared by the traders with respect to the expectations of the market. Among such expectations include the integration of market maker traits in instances of lower deviation from the price mean. However, the upper deviation may trigger retention of securities in anticipation of future disposal; leading to the development of the speculator mode. In essence, the occurrence of the two modes may be suggested to stem from the possible expectations that are shared by the traders with regards to the trends of the held securities (Fox et al., 191). In essence, the desire to improve on profitability may lead to the eventual development of decisions that may be considered contrasting to the expectations of the market.
(c). Explain why it is that, given a set of limit orders, a uniform price auction will always be efficient in the sense that after the auction takes place, the sellers who did not sell must necessarily have posted a higher price than those sellers who did sell, and the buyers who did not buy must necessarily have posted a lower price than those buyers who did buy. Compare this with other market mechanisms (other auction types, continuous limit-order books, etc.). What may be an argument for not always prioritizing efficiency?
Placing limiting orders on a uniform price auction introduces unique responses from the participating traders. In essence, the structure of an auction involves the presentation of the security for the highest bidder (Hu, 631). However, the concept of price uniformity allows the introduction of a sense of uniformity in the awareness of the market participants. In the case of limit orders, the concept of purchase is constructed along impressions of price as stipulated in the request. In essence, limit orders are considered to be overly depended on the price trends (Foucault, 358). Nonetheless, the implication of limit price, as well as the prospective lack of commitment on executing the transaction allows the appreciation of the expectations that are to be associated with their auction.
Evaluating the market approach engaged by the buyers would involve acknowledging their ability to strive towards securing the best bargains. A significant attribute regarding such a setting may be suggested to involve the element of limit price in the characterization of the order transactions. In essence, the pricing trend of the transacted orders involves exceeding the outlined limit price in the case of sales and a decline in the case of purchases. As a result, the model may be deployed in developing assumptions regarding the performance of both the seller and buyers from their volumes of transaction. Buyers willing to spend at the limit price are bound to secure favorable securities in comparison of their colleagues considering lower bids. Similarly, transaction analysis following the closure of the trading period will unveil the suggested disparity in the purchasing power of the buyers (Fox et al., 191). Buyers who were willing to purchase at the limit price will have higher purchases in comparison to their bargaining counterparts.
The occurrence of the suggestions made regarding the buyer and seller behavior is expected to materialize at the equilibrium of demand and supply. Possible mismatch in the forces of demand and supply would lead to the tilting of the transactions from the limit price. In such instances, reflecting on the market to appreciate the pricing strategy deployed would offer little significance to the development of the desired performance prediction.
Problem 3
Discuss, using real-life examples, how adverse selection (on both sides of the market) may affect market outcomes
Adverse selection is based on the outcome of asymmetric information as well its usage by the participating parties. In most cases, informed parties tend to use the acquired knowledge to their benefit in comparison to those uncertain of the trends. Developing a detail perception regarding the implication of the adverse selection may involve deploying illustration from market instances dissimilar from securities (Menkveld, 20). An ideal illustration would be considered in the electronic resell market where the interests of the buyers revolve around the integrity of the traders. In such a case, the buyer is challenged by questions regarding the purpose of sale in contrast to the sustaining the respective device. Reflecting on the security trade, the buyer faces similar concerns with respect to the virtues that lead to the promotion of the trade (Hu, 625). However, the elemental concern regarding adverse selection would be fetched from a case study where the concept of asymmetric information stands captured. Traders involved in electronic resells may be perceived to have limited information regarding the performance of the respective items (Fox et al., 191). Arguably, such occurrences are challenged by the inability of the sellers in communicating the reasons advising their sales. In a similar model, the performance of the security may be argued to be unclear to the involved brokers due to the lack of comprehensive information regarding the purpose of sell.
Making the assumption of asymmetric information involves appreciating the interests of the buyers towards the security. Apparently, buying a security is advised by the subsequent possibility of selling when the prices improve. However, the setting may be argued to tilt in the favor of the seller in comparison to the buyer. In the case of market makers, the prospect of participating in both the sale and buy of the securities may be argued to have an inclination on their attractiveness to the buyers. In essence, they participate in the purchase of the securities while disposing of them to the available buyers. However, the set-up may be argued to have an unfavorable diversion to the trader with regard to the expectations shared over the securities. Their case may be argued to comprise of sales team involved in used electronics that either is aware or unaware of the reasons behind the resells. Their ambition towards reselling may involve the obscuring some details from the clients in hope of securing a better deal. In the case of securities, traders may consider failing to disclose the information regarding the securities to the buyers in hope of maximizing their sales. In such cases, the implication of the adverse marker may be argued to be unfair to the buyer.
Distinction Between Traders and Market Makers
Extracting the distinction between the market maker and the trader is considered exceedingly challenging due to their interest in the participation of the market. Market buyers can consider reverting traders through the disposal of the hoarded securities. In such cases, their attribute as market markers is considered vacated (Hu, 625). Also, the role of the market makers in the provision of liquidity may be suggested to revolve on the maintenance of price stability in comparison to the interests of the traders who seek to capitalize on such changes (Yuan, 552). However, reflection involving the management of securities under the principles of taking liquidity may be argued as confusing with regards to the distinction between the two terms. Both parties tend to steer at gaining from the dynamics of the market during liquidity taking since they benefit from the anticipated gains. However, the eventual outcome of the concept of adverse selection is witnessed in the market outcome. In essence, market outcome involves the usage of the existing information against the buyer. Apparently, the buyer is convinced to participate in the transaction at the prospect of securing a prominent outcome (Foucault, 360). In return, the buyer is accorded a security of lower cost at a higher price limit.
The determination of the sizes of both market makers and the traders may be argued to be distinguished through reflections of the adverse effects. Reflecting on the illustration of the sale of used electronics, market makers are considered to relate to routine electronics shops dealing with the resold items. Traders, on the other hand, are considered by the parties that seek to broker the items for their clients without participating in the purchase. Instead, their interest is gathered as a passion of the transaction, or an order flow in a security transaction (Fox et al., 191). On assumption, the party that manifests the potential to purchase the security in anticipation of a forthcoming sale as well as the possible improvement in the price limit. Being unable to secure the anticipated price would lead to liquidity withdraw. Arguably, the reflections assist in defining the need for stable fiscal muscle in the management of the ambitions of the two parties. As a result, the trader may be suggested to be small or larger while the market trader is considered large. Apparently, the implication of the trader presuming both the small and larger description is defined by the subsequent ability of the market maker to enter into the disposal mode. In such case, the large institution would be suggested to have become a trader.
Regulation of Information Sharing
Regulation of information sharing among the different branches of large banks is founded on a potential conflict of interest with respect to the engagement of the involved transactions. In the case of large banks, their operations comprise of investment and brokerage operations. In essence, the introduction of adverse selection would introduce potential remodeling of the brokerage against the information gathered from the investment sector (Menkveld, 20). Arguably, such occurrences would have a damaging effect on the expectations according to the players in the market. Besides, the management of the information sharing models along concepts such as adverse selection may be considered a detrimental outcome in instances that neglect the principles regulated information sharing. In essence, the observation of the sharing regulation approach stands established towards the management of information from being used at the expense of the buyer. Failed regulation would imply in the introduction of possible room for security manipulation through the adverse selection model.
High-frequency Trading
The concept of selling used electronics may be considered in the exemplification of the suggested effects of information regulation. There exist numerous areas of conflict of interest when the buyer pool to comprise of the team that is involved in the resell of the secured electronics. Apparently, sharing information on the amounts of items sold may lead to the creation of the false perception of the product. Reflecting on the case of securities, the promotion of unregulated information sharing within large banks exposed the facility to concerns regarding the integrity of the engaged transactions. Adverse selection may be argued to have an impact on the implications associated with concepts such as high-frequency trading. High-frequency trading involves the moving of large volumes of securities in single trades (Yuan, 552). In such cases, the prospect of ensuring the engaged securities reflect on the accurate perceptions of the market as understood by the traders or the market markers remains considered a reasonable challenge. Instead, the buyers may be tricked to participate into stocks with values higher in accordance with the established limit prices. However, such products may have been developed through prospects such as the adverse selection model. As a result, the performance of such models may be argued to involve entities that seek to redefine the outcome of the market (Fox et al., 191). Participating in such a market may have pronounced outliers with respect to the anticipated market outcomes.
In conclusion, the concept of marker selection suggests different outcomes to the market expectations in both the seller and the buyer perspectives. Apparently, the shares limited knowledge on the existence of the adverse effect model while the seller participates in its crafting. In principle, the focus of the effect may be considered as the maximization of the associated revenues through the disposal of securities at higher price limits in contrast to their actual tags. Reflecting on the case of the buyers, the outcome of adverse selection is considered costlier in comparison to the expectations of the acquired securities. Arguably, the practice of adverse selection stands considered a manifestation of moral corruption since the practice involves taking advantage of uninformed or semi-informed players for profit maximization. Partaking in such practices corrupts market outcomes against the buyers.

Works Cited
Edmans, Alex, Itay Goldstein, and Wei Jiang. “Feedback effects, asymmetric trading, and the limits to arbitrage.” American Economic Review 105.12 (2015): 3766-97.
Foucault, Thierry, Johan Hombert, and Ioanid Roşu. “News trading and speed.” The Journal of Finance 71.1 (2016): 335-382.
Fox, Merritt B., Lawrence R. Glosten, and Gabriel V. Rauterberg. “The New Stock Market: Sense and Nonsense.” Duke LJ 65 (2015): 191.
Hu, Jianfeng. “Does option trading convey stock price information?.” Journal of Financial Economics 111.3 (2014): 625-645.
Menkveld, A. J.. “The economics of high-frequency trading: Taking stock.” Annual Review of Financial Economics, 8.1 (2016). 1-24.
Yuan, Yu. “Market-wide attention, trading, and stock returns.” Journal of Financial Economics 116.3 (2015): 548-564.