|  DEC 1988

Survival strategies for exchanges by Dr. Robert A. Wood

Survival strategies for exchanges by Dr. Robert A. Wood The rate of change in the structure of capital markets appears to be accelerating. Some forces affecting change are the evolution of futures and options markets, computerized trading which permits professional investors to focus liquidity demands of essentially unlimited size on exchanges instantly, trading strategies such as portfolio insurance, index arbitrage and ""hot money"" strategies which result in immense liquidity demands being placed on exchanges within very short time frames, upstairs block trades and, more recently, basket trades utilizing the Designated Order Turnaround (DOT) system for submitting computerized orders to the specialists. Capital formation is the basic economic force which drives exchanges. Financial executives and others involved in the business of capital formation ought to be periodically asking, ""Where should a particular stock be traded so as to minimize its firm's cost of capital?"" Assuming the financial intermediation process is functioning properly, the resolution of where to trade will determine the survival of exchanges. The stresses created by the rapidity of structural changes, exacerbated by the stock market break of October 19, 1987, threaten the survival of exchanges as presently constituted. This article focuses on three important aspects of the changing nature of capital markets. First, the rapid increase in liquidity demands by market participants and the associated changes in market behavior, Second, recent public attitudes toward futures and options markets and the implication of these attitudes for exchange survival, as well as potential solutions for these problems. Finally, the implication of allegations appearing in the press that markets are being manipulated through the use of basket trading.

by Dr. Robert A. Wood