Market microstructure shapes price behavior independently of underlying fundamentals

Evidence

After taking account of the volatility of the underlying stocks, Baker found that, contrary to the predictions of economic theory, option prices were more volatile in the larger crowd, an effect he explained by the tendency of this crowd to fragment into subnetworks when trading was intense. As one trader told him, “In the really large crowds that are really active, it’s possible to get trading in very different prices. [Why?] It’s noisy; you can’t hear” (quoted by Baker 1984b, p. 786). The small crowd, in contrast, tended to remain stable in membership, and always small enough for easy communication. Prices in it tended to remain stable, even as trading became more intense. — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 88

Categorization

• XREF: Directly echoes the performativity thesis that market structure, not just information, determines prices — connects to MacKenzie/Millo and sociological economics of finance. — connects to: Market microstructure shapes whether arbitrage opportunities persist or vanish — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 94; Fundamentally unrelated market phenomena can suddenly move in lock-step within a global microstructure — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 1088; Exchange market microstructure determines how well put-call parity prices are maintained. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 756 (+2 more)
• QUESTION: Baker’s fragmentation mechanism — does modern electronic trading with millisecond quotes resolve the ‘can’t hear’ problem, or simply relocate it?

Related

• Exchange market microstructure determines how well put-call parity prices are maintained. (similarity 0.84)
• Market microstructure shapes whether arbitrage opportunities persist or vanish (similarity 0.83)
• Larger trading crowds produce more volatile prices than smaller ones (similarity 0.83)

Broader Connections

• Exchange market microstructure determines how well put-call parity prices are maintained. #exemplifies (0.80) — Donald MacKenzie, An Engine, Not a Camera, 756
• Fundamentally unrelated market phenomena can suddenly move in lock-step within a global microstructure #corroborates (0.75) — Donald MacKenzie, An Engine, Not a Camera, 1088
• Competition drives price toward exchange value determined by embedded labour #qualifies (0.72) — Yanis Varoufakis, Technofeudalism, 787