The Microstructure of Secondary Securities Markets: A Comparative Historical Perspective

We propose examining the results of a natural experiment run by the world's leading stock exchanges from 1801 to 1971. In this period, the formal securities markets of London, New York, and Paris traded a broad set of similar securities while operating under distinctively different rules for governing their trading procedures and the flows of information among participants-what we call today the market's microstructure. We will combine a comparative with an historical analysis to assess the differential impact of alternative microstructures adopted by these markets, and to determine how and why they evolved.

While the microstructures of established contemporary markets in the US, Britain, Europe, and Japan have been studied intensively, it is still not clear how market rules evolve and perform over long periods of time in different countries. In our study, we examine the effects of financial crises, war finance, changes in monetary regimes, improved communications technology, and the rise of new industries on the first emerging markets-London, Paris, and New York-from their formal beginnings at the beginning of the nineteenth century. By exploring how these earlier markets met precisely the challenges confronting regulators and practitioners in emerging markets today, we hope to show which forms of microstructure are most robust with respect to different legal, political, and financial systems.

The time span covered by our natural experiment encompasses three distinct epochs, each one capable of yielding distinctive insights relevant to today's emerging markets. In the first period, 1801 to 1880, the three markets dealt with the problems of war and postwar finance on a massive scale. The transition economies emerging today from the economic rigors of the Cold War have much in common with the new nations that arose in Latin America and continental Europe in that much earlier period. The classic gold standard period of 1880-1914 was a period when a largely free international capital market emerged. The innovative products created in that period resemble in intent and effect many of the financial products that have been developed in past decades to minimize exchange rate risk, country risk, and interest rate risk. The years from 1914 to 1971 saw for all intents and purposes the abolition of free international capital markets. As individual governments respond differentially to the shocks of the global capital market today, we may expect to see many similar initiatives to constrain both capital movements and speculative activity.

Economic theory helps to assess the likely impacts on trading behavior given the different incentives and quality of information that can be generated by alternative microstructures. What is missing to date is a systematic analysis of the impact of different microstructures on capital markets operating under alternative regulatory and legal environments. By contrast with the brief experience guiding practitioners and students of today's emerging markets, we are able to specify the evolving microstructures of each market and assess their effects on market liquidity, efficiency, trading costs, and volatility over the course of a century and three-quarters. The results of our project will be useful to practitioners, regulators, and researchers confronting the problems of designing securities markets both in the transition economies and in the less developed areas of the world, not to mention redesigning markets in the advanced economies.