Korea Capital Market Institute

This study aims to find ways to improve the mechanisms to execute block trades. There are currently two block trading facilities available on the exchange ? the reported block trading and off-hours block trading. These two facilities were instituted in order to mitigate the market impact of block trades during the regular session by limiting block trading to the opening and closing hours of the exchange and during off-hours. Nevertheless, most of the block trades are actually taking place during regular sessions, contrary to the original intention of these facilities. As a result, block trades are having a larger impact on the market and increasing intraday fluctuations. There is a need, therefore, to examine ways to improve the block trade system in a way that will reduce market impact and intraday fluctuations. In addition, institutional investors are expected to account for a larger share of the securities market when pension funds increase investments in equities. Since this will lead to an increased demand for block trades, it is all the more important to improve the transaction mechanisms so that the trading environment of institutional investors can be improved. Block trades refer to trades whose trade sizes are too large to be executed through the standard trading procedures. Block trades are inherent with problems such as latent demand and asymmetric information. The latent demand means that the liquidity provider in a block trade does not want to reveal his intention of trading; and the asymmetric information means that the liquidity provider is reluctant to provide liquidity over concerns that the trading counter party has more information than he does. In order to address such inherent problems, parties to the block trade need to exchange information other than price and order volume. The transaction mechanism in the regular session, however, does not provide a means to do so. Consequently, many major exchanges now operate an upstairs market in addition to the regular downstairs market. According to Bessembinder et al.(2003), an upstairs market is more useful in an electronic order-driven market such as the Korean stock market where there are no designated market makers. Although the Korean exchange introduced “K-BLOX,” a network supporting quote displays and negotiations, it is hard to say that this is a full-fledged upstairs market. The first reason is because the time for using the block trade facility is limited to the pre-trade, post-trade and off-hours sessions. The second reason is because it does not have a system for the trading parties to exchange information other than price and order volume. This report first examines block trades of the 200 stocks comprising the KOSPI 200 index during the period from January to June of 2003. The study showed that the block trades represented 43.14% of the total volume. However, in terms of the number of trades (1.35%) and the transacted value (13.90%), block trades did not account for such a large share. The reason why block trade does not account for a significant portion in the number or value of trades is because individual investors account for a larger share of the market as opposed to institutional investors. This is because the lower the market participation of institutional investors who require block trades, the less the demand for block trades. On the other hand, there is the possibility that demand for block trade exists but has not surfaced under the current block trade system. Meanwhile, it was found that most of the block trading took place during the regular trading hours where the block trade system was not introduced. The share of block trading, consisting of reported block trading (number of trades: 1.72%, traded volume: 2.14%, traded value: 7.90%) and off-hours block trading (number of trades: 1.72%, traded volume: 2.14%, traded value: 7.90%), was very low. In contrast, the share of block trades that t