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29 Feb 2016

Empirical Market Microstructure Studies of the Indonesia Stock Exchange (IDX)

Josephine Sudiman, February 2012
Edith Cowan University

Abstract
The overall aim of this study is to improve the understanding of how two market elements within microstructure theory, namely the regulatory and behavioural aspects, influence trading dynamics in the Indonesian Stock Exchange (IDX). This market was chosen because it is my country’s exchange and has distinctive features, including its outstanding performance among developing equity markets and its requirement for information transparency.

As trade initiators are an important part of our methodology but neither of the two databases (the Detailed Trading History of IDX and Thomson Reuters Tickscope History by SIRCA) provide this information, four different trade initiation rules are applied to assist the study of this issue. They are 1) the tick rule, (2) the Lee & Ready method (1991), (3) the Ellis, Michaely, & O’Hara (2000) method, and (4) the chronological order rule. We demonstrate that the methods of Lee and Ready (1991) and Ellis, Michaely, and O'Hara (2000) provide results which conform closely to the chronological rule; however, this is not the case for the tick rule.

In terms of the regulatory viewpoint, this study investigates the impact of tick size changes in 2000 on liquidity provision in the IDX. Our methodology follows Engle & Lange (2001) who combined price durations (time needed for a price to move at or more than a tick size) with the cumulative signed volume (the difference between the number of shares purchased and number of shares sold) transacted over the price duration, expressed as the V-Net, to study the impact of tick size on market time, size and price dimensions. The results suggest that the implementation of a single tick size for different price levels is inappropriate for the IDX, and the current policy of multiple tick sizes is preferable. For frequently-traded stocks, a small tick size is not necessarily helpful for improving liquidity with high price shares but it is for those with low prices. Both price durations and V-Net metrics were higher during periods with coarse tick sizes. Moreover, lower price duration and V-Net metrics are identical to the circumstances featuring lower spreads and lower depth during small tick sizes.

In terms of the behavioural perspective, this research identifies the characteristics of the stock holdings of foreign and domestic investors, and their trading behaviour, relative profitability, and trading impact along with the associated implications for the price discovery process. We found that foreign institutional investors consistently hold high market capitalisation stocks and have a long-term investment horizon in the IDX. Therefore, they are willing to pay high buy prices and accept low sell prices. Subsequently, their trades are more likely to be associated with changes in midpoint quotes and have a high impact on price changes. Local investors are generally short-term traders; they trade frequently and submit non-competitive orders because they obtain profits from the bid and ask differences. However, there are some local investors who trade based on information and are able to update their private information quicker than foreign investors.

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