What is Market Microstructure?

M. McGee
M. McGee
Man climbing a rope
Man climbing a rope

Market microstructure is the study of how markets operate. This area of study looks at the markets as a whole, regardless of what is being bought or sold. Even though it studies all aspects of every market, financial markets get the most attention. Market microstructure research works to understand how the market influences prices and actions by virtue of the systems it uses to operate. Researchers believe this ‘meta-market’ has a major impact on the day-to-day operations of every marketplace.

A market, from a financial standpoint, is a structure that allows the buying, selling and trading of goods and services. Most markets have specific focuses that define their existence. For instance, the real estate market is a specific market devoted to the buying and selling of one type of good. While every market has certain financial structures in common, any individual market has specific methods of operation that are unique.

The study of market microstructure focuses on the structures and practices of every marketplace. This branch of research looks at the individual traits and how they work with the larger methods to create a unique market. In addition, it studies how the structures of the market itself influence the ups and downs in the system, from the prices people pay to fees they incur.

There are two reasons why market microstructure researchers generally focus on the financial market more than others. The main reason is the sheer numbers of transactions. Each second the market is open, people are buying and selling goods. At the end of the day, tens of thousands of transactions have begun and ended.

The secondary reason is the bookkeeping involved in the financial market. Since there are so many actions happening all at the same time, diligent record keeping is required to keep it all straight. This, along with the volume of sales, makes it easier to spot trends and actions in the market.

There are four main factors that market microstructure researchers focus on. The first, and most important, is the structure of the market itself. This is centers on aspects like the methods used to sell goods, such as direct marketing, storefronts or brokerage. The idea here is finding markets that are best suited for individual market activities.

The other three factors come from the basic structure of the market. The study of pricing looks at the methods the individual structure uses to set the prices for its products. Costs are studied to see how the different structures generate different operation costs and how they affect the market. The study of transparency looks at the way the individual methods of the market are portrayed to the customers for that market—for example, how the fees and costs of buying a new home are communicated to buyers and what the buyers think of them.

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