New Research Provides Overview of Market Microstructure Regulation

Market microstructure refers to the organization and design of markets for trading, how these markets are regulated, and how investors approach trading. In a new article, researchers provide an overview of the regulation of market microstructure, particularly in equity and option markets.

The article, by researchers at Carnegie Mellon University and the University of Maryland, is published in the Annual Review of Financial Economics.

“Given the presence of a range of externalities, adverse selection, and moral hazard associated with trading and payment systems, market structure is relatively heavily regulated,” explains Chester Spatt, Pamela and Kenneth Dunn Professor of Finance at Carnegie Mellon’s Tepper School of Business, who coauthored the article. “Reflecting the special circumstances in various markets, the regulatory regimes for equity trading, option trading, and fixed-income trading are somewhat distinct due to differences in inherent trading activity, liquidity, and the nature of the underlying risk exposures.”

In their article, the authors emphasize the motives for regulation and restrictions on the trading process, including the distinctive regulatory environments (and regulators) for different financial instruments, as well as the role of brokers in routing trades and market makers who intermediate trade. They discuss the pricing and role of various intermediaries and regulators, especially brokers and trading platforms, and consider the role of regulators.

In addition, the authors highlight such central features of the design of markets as best execution responsibilities; order protection (trade-through) restrictions (Regulation National Market System); payment for order flow, tick size, and access fees; and the role of auctions, transparency, and short-selling restrictions. They also point to some of the distinctive features of fixed-income trading and market design and the emerging role of litigation in determining regulatory outcomes.

Among the key regulatory issues they address are the extent of transparency (both pre- and post-trade), coordination across trading venues, and the responsibilities on behalf of customers by both brokers and market makers in routing and intermediating trades.

“Our work examines the role of regulators, which is important given the underlying adverse selection, incentive conflicts due to moral hazard, and externalities,” notes Thomas Ernst, Assistant Professor of Finance at the University of Maryland’s Smith School of Business, who coauthored the article.

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Summarized from an article in the Annual Review of Financial Economics, Regulating Market Microstructure, by Ernst, TH (University of Maryland), and Spatt, CS (Carnegie Mellon University). Copyright 2025 The Authors. All rights reserved.