This article describes the concept of a stock market, outlines its historical development and its role (in a capitalist economy) in raising finances for corporations to expand. Different exchanges in the U.S. and around the world as well as the rapid development of the system of stock trading are also discussed. The process whereby a corporation first issues shares to the public through an IPO and then how those shares are later traded on the secondary market is explained. Specifically, the increased role of technology, the diminished role of traditional stock brokers, and how the stock market industry has moved well into a new era of computerized screen-based trading is reviewed.
Keywords AMEX; Bid-ask spread; Broker — dealer; Decimalization; ECN; Electronic Trading; Equities; Initial Public Offering; Liquidity; NASDAQ; New York Stock Exchange; Price Discovery; Program Trading; ROE: Return on Equity; Secondary Market; Securities and Exchange Commission; Stock Exchange; TMT: Technology — Media — Telecom; Transparency; Volatility
The stock market is an organized system for the trading of securities. A security is a type of financial asset issued by a corporation and represents a legal interest in that corporation that can be transferred from owner to owner. The stock market acts as a means for owners, or investors, to quickly buy or sell their stocks, or shares. Traditionally, US stock markets, also know as equity markets, have focused almost exclusively on the publicly listed equity securities of US based corporations and have traded them through a floor based broker system. However, over the last decade, stock markets, traditionally based around a set handful of specific stock exchanges, have also introduced trading in a huge variety of new securities, such as bonds, derivatives, Exchange Traded Funds (ETFs), options, and even commodities. There has also been a dramatic move away from the old face-to-face method of trading securities and towards electronic automated trading. Additionally, the reach of the US stock market has expanded globally to include the trading of securities issued by foreign corporations between not only US-based buyers and sellers, but also foreign investors as well. Different stock markets throughout the US and throughout the world now aggressively compete for business from corporate issuers. Major Asian and European corporates are just as likely to list their shares in New York as in Tokyo or London.
Historically, the stock market was based at a fixed physical location. Within the US, while the New York Stock Exchange (NYSE) based in New York City is by far the largest, there are also a large number of smaller regional exchanges. These regional exchanges are located in Boston, Cincinnati, Chicago, Los Angeles, Miami, Philadelphia, Salt Lake City, San Francisco, and Spokane. The largest over the counter stock market, where stocks are traded electronically through a computer network rather than at a physical exchange, is the NASDAQ Stock Market (National Association of Securities Dealers Automated Quotation system). NASDAQ had gained prominence in the late 1990s because a bulk of the companies listed were in the telecom, technology or media sectors (TMT) — which all experienced huge price appreciation. The prices of NASDAQ stocks peaked in 2001 and then entered into a steady, sharp decline. The decline in prices resulted in huge investor losses and a number of new government initiatives regulating the operations of stock markets as well as how corporations disclose financial information and communicate with their shareholders.
Internationally, all major industrialized nations also have stock markets. Outside of the US, the world's largest stock markets are located in London, Paris, Tokyo, Hong Kong, and Toronto. The major over-the-counter market in Europe was The European Association of Securities Dealers Automated Quotation system (EASDAQ), which is now a part of the New York-based NASDAQ. While some international exchanges have a centralized location, more and more are moving towards screen-based systems where a physical presence at the exchange is not required. Today, the distinction is rapidly becoming blurred and intertwined between a centralized stock market and a national screen based system as there has been a wave of consolidations and alliances between many different exchanges. The landscape of the stock markets and the exact method of how they operate are rapidly changing and are still very much works in progress.
Since the New York Stock Exchange (NYSE) is the world's largest market for publicly listed equity securities, activities on NYSE, whether in terms of daily prices or how the exchange actually functions, are felt by other stock markets throughout the globe. The NYSE can trace its roots back to 1792 where traders met on a sidewalk on Wall Street in New York City. It officially adopted the name of the New York Stock and Exchange in 1863. Since 1868, membership, represented by a "seat," which gives the right to trades securities on the exchange, could be acquired through purchasing a seat from other members. Since 1953, the number of seats has been limited to 1,366.
By the 1920s, the stock market had progressed so rapidly in terms of both daily trading volume as well as the number of companies listed; is became widely viewed as a barometer of the economy where huge fortunes could be made — or lost. The stock market crash of 1929, in fact, marked a sort of unofficial beginning to the Great Depression. The crash also marked a turning point from an era where the federal government did as little as possible to interfere with the markets, to a new era where the stock market has become one of the most heavily regulated institutions in the national economy. Today, federal securities laws of the United States require the registration of stock exchanges and of all securities that are listed for sale to the public. A security must be registered with the United States Securities and Exchange Commission ("SEC") and be approved for listing by a registered stock exchange before it can be traded on any exchange. All stock exchanges have their own listing standards concerning the type of security listed and any possible restrictions on the investors who trade in it as well as requirements for continuing disclosure of financial information by the issuer.
The golden era of the stock market, which arguably may never be repeated for a generation or more, occurred from 1996 to 2001. Trading margins expanded and the market for Initial Public Offerings (IPOs) soared in volume. IPO volumes rose from $29.9 billion in 1995 to more than $61.8 billion in 1999 (Hintz, B., & Tang, K. L., 2003). Institutional equities headcount, the number of people employed in the equity divisions of Wall Street financial institutions, expanded rapidly. The equity business grew its sales and trading activities as well as its research coverage. Institutional equity earnings peaked in 1999, with the Return on Equity (ROE) attained by Wall Street firms averaging over 40% (Hintz, B., & Tang, K. L., 2003). For the first time, many ordinary U.S. households began to individually pick and buy stocks — as opposed to merely investing in mutual funds selected by their financial advisor. The equity culture was finally established in the American psyche. In 2000, as the TMT boom wound down, equity IPO volumes fell 30% year-over-year between 2000 and 2001 and another 47% between 2001 and 2002 (Hintz, B., & Tang, K. L., 2003). More importantly, prices, particularly for the TMT heavy NASDAQ, suffered a dramatic drop and wiped hundreds of billions of dollars in wealth out of the personal savings of the same ordinary households that first began buying stock just a few years earlier.
Technology Squeezes Pricing
Today, the stock market is back in full force as a major, albeit declining, profit center for Wall Street firms as well as a huge center of attention for the investing public at large. Even major media conglomerates generate a significant share of their advertising revenue by reporting on the minute to minute developments in the market. NYSE seats are now sold for some $3.5 million each and have been sold for as much as $4 million. Daily trading volume on the NYSE, which was limited to about 100 million shares daily in the early 1980s, routinely topped 4 billion per day in 2008 (New York Stock Exchange) but by 2013 averaged about 3 billion per day (Mandaro, 2013). More than half of this trading is executed not by individual investors picking up the phone and placing an order, but through automated systems known as algorithmic trading, also referred to as program trading. Program trading is the generic name given to various trading strategies defined as the simultaneous purchase or sale of a group of stocks based on a mathematical set of rules. The NYSE defines program trading as the purchase or sale of at least 15 stocks with the value of the trade exceeding $1 million. Program trading accounted for approximately 9.9% of total NYSE volume in 1989, rose to 18% in 2001 and to 27% in 2002, and it has been as high as 40% of total volume by 2003 (Hiliman, 2004). Program trading has substantially increased daily trading volumes on the stock markets which is widely perceived as beneficial for investors. However, at the same time, program trading has dramatically increased volatility where 1% or 2% daily price movements are far more common today than in decades past. (Hiliman, 2004).
Virtually every significant player in the stock market has heavily invested in program trading technology in order to help make trading more cost efficient as well as to help formulate complex trading strategies. Large mutual fund companies managing trillions of dollars in assets with multiple portfolio managers have found program trading to be an easy way to reduce execution charges and "stretch" the budgets they allocate toward stock trading commissions during weak business cycles.
Perhaps the most significant development for both the NYSE as well as the global industry of trading stocks occurred in April 2007, when NYSE formally completed the acquisition of Euronext, a European screen based equity trading system spanning the continent. Then in 2013, NYSE Euronext was itself purchased by IntercontinentalExchange (ICE) (Kierman & Bunge, 2013). These acquisitions formally signified that the stock market was no longer a localized market composed of individual brokers meeting face to face to trade securities by verbally agreeing to a price. Instead, the stock market is increasingly a globalized electronic system based on an advanced real time technology platform encompassing investors and equities form around the world. The exact roles that human beings will play in operating this giant financial cyber world, other than simply maintaining the machines, still remains to be fully determined.
Electronic trading and price discovery through an electronic system, rather than the traditional floor based face to face verbal...
Indian Equity Markets: Measures of Fundamental Value
NBER Working Paper No. 16061
Issued in June 2010
NBER Program(s):Asset Pricing
In this paper, we take a critical look at the relationship between the value of capital stock in the Indian corporate sector and the valuation of claims to this capital stock in capital markets. We address the question of whether Indian equity valuations over the period 1991- 2008 are consistent with three key market fundamentals: corporate capital stock, after tax corporate cash flows and net corporate debt. Our analysis extends the neo-classical growth model to include intangible capital and key features of the tax code and uses national account statistics to estimate the equilibrium value of corporate equity relative to GDP. Our framework can provide policy makers with a benchmark to identify deviations in equity markets relative to those implied by economic fundamentals. In addition, it facilitates a quantitative assessment of policy changes such as, for example, the effect of changes in dividend taxation on stock prices. We caution the reader that although our framework is well suited to examining secular movements in the value of equity relative to GDP, it is not suitable to address high frequency price movements in the stock market. In fact, we know of no framework that can satisfactorily account for these movements in terms of the underlying fundamentals. High frequency volatility remains a puzzle. Based on our analysis, we conclude that in a large measure, Indian equity markets were fairly priced over the 1991-2008 period.
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Document Object Identifier (DOI): 10.3386/w16061
Published: “Indian Equity Markets: Measures of Fundamental Value”, India Policy Forum , Volume 6, 2010, pp 1 - 30 citation courtesy of