Stock Markets
London or Milan?

In 1985 the London stock exchange created Stock Exchange Automated Quotation (SEAQ) International, a screen-based price- quotation system devoted to trading in the shares of non-UK companies, which has attracted considerable trading volume, especially in the `blue chip' stocks listed on European exchanges. The shares of the major Continental European companies are now traded both on the auction markets of their own stock exchanges and on SEAQ in London. The Italian sector of SEAQ International, which began operations in 1989, has grown impressively, probably spurred by the relative backwardness of the Milan stock exchange. This still retains the traditional batch auction system, whereas other European exchanges such as Paris and Madrid have scrapped the traditional batch auction and open outcry trading in favour of continuous auctions and automatic order execution.

In Discussion Paper No. 564, Research Fellows Marco Pagano and Ailsa Röell investigate the relationship between the London market for Italian equities and the Milan stock exchange as a case-study of the competition and interaction between a dealers' market and a traditional batch auction market. They first inquire whether the London market for Italian equities has so far thrived on `trade diversion' or `trade creation'. They find that the London market has grown by stimulating new trade rather than at the expense of Milan, but they view this result with caution because of shortcomings in their volume data for both markets.

Pagano and Röell then consider the two markets' interaction in determining prices. By testing for the existence of arbitrage opportunities, they show that prices in the two markets are generally in line, but this alignment is not perfect. Further, for most dually-traded stocks, Milan appears to lead London in price formation, so SEAQ market makers appear to refer to Milan prices to set their quotes. This informational spillover is rather weak, however, and definitely less important than for French dually-traded stocks.

Finally, Pagano and Röell analyse the possible influences of transaction costs, market liquidity, geographical externalities and the design of the trading system on the location of Italian equities trading to examine possible reasons why so many traders prefer to trade Italian shares in London. They find that relative transactions costs cannot account for the growth of the London market, whose comparative advantage is probably explained by a set of factors that are harder to measure. These may include its greater ability to absorb large transactions with only small changes in price, locational advantage, its greater immediacy due to the continuous nature of the dealers' market, or features of dealership attractive to certain classes of traders, such as the implied insurance against execution risk and the possibility of gaining liquidity through a long-term relationship with a particular dealer.

Dually-Traded Italian Equities: London vs. MilanMarco Pagano and Ailsa Röell

Discussion Paper No. 564, July 1991 (AM)