Effects of Automated Trading on Market Microstructure

Very Hard Equity Market Structure Market Microstructure

In the context of modern equity markets, the mechanism of price discovery plays a vital role. Consider a hypothetical small-cap stock, XYZ Corp., traded on a decentralized exchange. This stock has relatively low trading volume and a wide bid-ask spread due to its less active trading environment. Recent regulations have allowed for the introduction of automated trading systems that facilitate liquidity provision and order matching.

Given this scenario, which of the following statements most accurately reflects the implications of this change on market microstructure?

The introduction of automated trading systems will lead to narrower bid-ask spreads and increased market efficiency, ultimately enhancing the price discovery process.

Automated trading systems will primarily benefit institutional investors, exacerbating information asymmetry and potentially increasing transaction costs for retail investors.

As liquidity increases due to automated trading, the price volatility of XYZ Corp. will diminish regardless of the underlying fundamentals.

Hint

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