Optimal Microstructures


  • This article was delivered as the Keynote Address at the European Financial Management Association meetings (EFMA), Madrid, Spain July 2006. I would like to thank John Doukas, David Easley and Richard Green for very helpful comments.


This paper considers the basic issue of the optimal microstructure for trading financial assets. I propose a framework for addressing optimality that draws on the functions that markets perform. These functions include liquidity, price discovery, and the reduction of uncertainty. Because the characteristics of financial assets and their investors differ, I show that their optimal microstructure may differ as well. I illustrate these points by analysing the evolution of corporate and municipal bond trading in the USA. The paper also discusses the particularly important role that microstructure plays for developing financial markets.