Forgery, market liquidity, and demat trading : Evidence from the national stock exchange in India
Aney, Madhav S.; Banerji, Sanjay (30.05.2024)
Numero
7/2024Julkaisija
Bank of Finland
2024
Julkaisun pysyvä osoite on
https://urn.fi/URN:NBN:fi-fe2024053041567Tiivistelmä
We analyse the impact of the introduction of a new technology on the National Stock Exchange in India that allowed trading of stocks without the need to transfer paper share certificates (demat trading). We document a decrease in the bid-ask spread and an increase in trading volume following its introduction particularly for those stocks that were previously illiquid. We present evidence that suggests that the primary channel for the increase in liquidity was the elimination of the risk of being sold forged securities as the clearing system took on the risk of reimbursing buyers of forged shares at the introduction of demat trading.
Julkaisuhuomautus
NON-TECHNICAL SUMMARY
FOCUS
Fraudulent transactions occur frequently in financial market platforms in both advanced and emerging countries. To restore trust of the investors in the market, regulators and policy makers often resort to digital technology to address fraud. This is done by dissemination of information as well as through detection of fraud and prevention of such transactions. Sometime new entrants with updated technology force the existing platforms to improve governance. However, creation of an altogether new stock exchange in response to widespread fraud in trading is rare. In this paper, our focus is to study the impact of the creation of a new stock exchange in India (known as the National stock exchange), accompanied by technological and institutional changes to examine whether it had a first-order effect on liquidity and volume of transactions on the firms listed on the new exchange.
CONTRIBUTION
We use a unique proprietary dataset to present the evidence of recorded fraudulent transactions in the rival stock exchanges (the Bombay Stock Exchange) relying on an older technology. We use the daily bid-ask spread and transactions in the newly established National Stock Exchange to examine the effect of its creation on these variables. We argue that the creation of the new exchange along with its technological and institutional features led to a decrease in the trading of forged shares. Moreover, we also discuss the potential channels that could have mediated these changes and attempt to show that the changes were primarily driven by a shift in the expectations of the players in the market about the consequences of being sold forges shares.
FINDINGS
We document a decrease in the bid-ask spread and an increase in the trading volume following the introduction of demat trading at the National Stock Exchange. These changes are particularly pronounced for those stocks that were previously illiquid. We present evidence that suggests that the primary channel for the increase in liquidity was the elimination of the risk of being sold forged securities as the clearing system took on the risk of reimbursing buyers of forged shares at the introduction of demat trading. We show how these empirical results are consistent with a simple Lemons model where the introduction of the new technology eliminates the presence of forged shares.
FOCUS
Fraudulent transactions occur frequently in financial market platforms in both advanced and emerging countries. To restore trust of the investors in the market, regulators and policy makers often resort to digital technology to address fraud. This is done by dissemination of information as well as through detection of fraud and prevention of such transactions. Sometime new entrants with updated technology force the existing platforms to improve governance. However, creation of an altogether new stock exchange in response to widespread fraud in trading is rare. In this paper, our focus is to study the impact of the creation of a new stock exchange in India (known as the National stock exchange), accompanied by technological and institutional changes to examine whether it had a first-order effect on liquidity and volume of transactions on the firms listed on the new exchange.
CONTRIBUTION
We use a unique proprietary dataset to present the evidence of recorded fraudulent transactions in the rival stock exchanges (the Bombay Stock Exchange) relying on an older technology. We use the daily bid-ask spread and transactions in the newly established National Stock Exchange to examine the effect of its creation on these variables. We argue that the creation of the new exchange along with its technological and institutional features led to a decrease in the trading of forged shares. Moreover, we also discuss the potential channels that could have mediated these changes and attempt to show that the changes were primarily driven by a shift in the expectations of the players in the market about the consequences of being sold forges shares.
FINDINGS
We document a decrease in the bid-ask spread and an increase in the trading volume following the introduction of demat trading at the National Stock Exchange. These changes are particularly pronounced for those stocks that were previously illiquid. We present evidence that suggests that the primary channel for the increase in liquidity was the elimination of the risk of being sold forged securities as the clearing system took on the risk of reimbursing buyers of forged shares at the introduction of demat trading. We show how these empirical results are consistent with a simple Lemons model where the introduction of the new technology eliminates the presence of forged shares.