| Summary: | The London Stock Exchange is constantly changing as the global financial landscape evolves. By aggregating detailed intraday trading data, I analyse its liquidity for a period spanning the introduction of a pure electronic order book platform for the most liquid stocks in 1997, its expansion to include less liquid stocks with market maker participation, the structural and environmental changes brought about by MiFID regulation in 2007, and the beginning of the global financial crisis. By all measures, liquidity has increased over the years, although recently intensified competition from alternative trading venues may be limiting further improvement. The most liquid stocks are the constituents of the FTSE 100 index, which are picked by largest market capitalization. When a new stock is added to this index there is a temporary price effect which I ascribe to the closing auction just before the index is revised. This is a natural time for passive investors who track the index by replicating its composition to adjust their portfolio holdings. The auction trade is facilitated by a build-up of liquidity on the opposite side of the order book in advance, as limit orders are placed in competition to take the other side of this information-free order flow at a premium. Naturally, ordinary trading in index constituents does contain information about individual stocks, groups of stocks and the entire market. Conveniently, another liquid security trades on the market which can be used as a conduit for the latter information: the FTSE 100 exchange-traded fund. Due to arbitrage opportunities its price is closely related to the index, and in fact I determine that they are cointegrated, even intraday. According to the eo integration analysis the fund makes a significant contribution to the index price discovery process, and this is especially evident when order flows are incorporated into the model.
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