We study the relation between foreign exchange market quality and both trading activity and dealer concentration by considering two currency pairs with significant differences along both dimensions – the Euro–US dollar and Canadian dollar–US dollar. A variance ratio test reveals over-reaction in currency prices, but that this is smallest when trading activity is high and dealer concentration at its peak. A GARCH model shows that over-reaction declines as trading activity and dealer concentration increase, with the results being stronger for the Euro. Our results confirm that trading activity is an important determinant of market quality, but also point to a significant role for dealer concentration.

We find that the order flow differential (OFD), a flight-to-quality measure constructed as the difference between large- and small-cap stock order flows, strongly and negatively forecasts output growth and interest rates in the U.S. The predictive ability of OFD for future macroeconomic fundamentals is robust to the inclusion of return factors and business cycle predictors, and it is thus a state variable candidate in the spirit of Merton (1973). Consistent with this view, we document that OFD commands a statistically significant negative risk premium in cross-sectional asset pricing tests.

Weights in the Toronto Stock Exchange 300 index are determined by the market values of the included stocks' public floats. In November 1996, the exchange implemented a previously announced revision of its definition of the public float. This revision, which increased the floats and the index weights of 31 stocks, conveyed no information and had no effect on the legal duties of shareholders. Affected stocks experienced statistically significant excess returns of 2.3 percent during the event week, and no price reversal occurred as trading volume returned to normal levels. These findings support downward sloping demand curves for stocks.

We examine the importance of indexing, industry, and broad market forces in driving common effects in order flow, returns, and trading costs. Common effects are strong for order flow and returns in a sample of S&P 500 stocks, but are weak in a sample of non-index stocks and for trading costs in both samples. Industry and broad market effects exist in order flow for both samples, but indexing effects are dominant. Correlated order flow drives common effects in returns and, to a lesser extent, those in trading costs. An event study of the effect of index addition on order flow and return comovement reinforces these conclusions. Our results show that common effects are not pervasive and have implications for diversification strategies and price formation models.

We find that the aggregate asset allocation decisions of US mutual fund investors depend on economic conditions. Both anticipated economic downturns and periods of turmoil lead investors to direct flow away from risky equity funds and towards lower-risk money market funds. These patterns are markedly stronger for investors in low cost and low turnover funds relative to investors in high cost and high turnover funds, consistent with sophisticated investors being more sensitive to changing conditions. Benchmarked against a buy-and-hold strategy, these asset allocation strategies reduce risk without degrading the risk-return trade-off. Our evidence suggests that individual investors, often dismissed as noise traders, collectively react to economic signals in a sensible manner when determining asset allocations.

Studying a comprehensive sample of stocks from the U.S. OTC market, we show that this market is a large and diverse trading environment with a rich set of regulatory and disclosure regimes, comprising venue rules and state laws beyond SEC regulation. We exploit this institutional richness to show that OTC firms subject to stricter regulatory regimes and disclosure requirements have higher market quality (higher liquidity and lower crash risk). Our analysis points to an important trade-off in regulating the OTC market and protecting investors: lowering regulatory requirements reduces the compliance burden for smaller firms, but it also reduces market quality. Received July 26, 2013; editorial decision July 8, 2017 by Editor Itay Goldstein.