Market microstructure has been an ignored and little understood area of research in the context of Indian commodity markets. As a branch of finance, market microstructure is concerned with the details of how exchange occurs in markets.

As a field of research, market microstructure requires serious mathematics and econometrics, rich microeconomic theoretical knowledge, and strong market perceptions.

The dearth of research in India in this field has often led to several important strategic concerns related to the commodity markets being dealt through subjective perceptions and findings based on overtly simplistic mathematics. Yet, the history of this research in India is not so impoverished.

Research on commodity market microstructure in India traces its origin back to the 1930s, with research on cotton futures market in Mumbai by ML Dantwala and HL Dholakia.

A book by LS Venkataraman on the theory of futures trading in the ?60s and a host of articles and monographs by M Pavaskar were noteworthy. However, these publications never explicitly mentioned the term ?market microstructure?, probably because the term was coined for the first time in an article by M Garman in 1976.

All these researches on commodity market microstructure in India conducted in the ?60s and ?70s were important from a policy perspective and helped create a baseline, which later researchers failed to take advantage of. This enthusiasm for research petered out as commodity futures markets were abandoned in the country since the mid-60s.

In the absence of a derivative market for commodities, commodity research practically died out. With the revival of commodity trading in the 1990s, and the setting up of national-level exchanges in the new millennium, there was a renewed interest in research on commodity derivative markets.

However, microstructure research never really took off; the pitiful few were forced by policy considerations, rather than being conscious efforts in conducting academic research.

An extensive literature on market microstructure, however, exists on the financial markets of the developed world, particularly on the markets in the US. The studies can be classified into three categories: the actual transaction process, the effects of market structure and trading rules on the transaction process, and the implications of the transaction process for fundamental economic decisions.

Some critical concerns of microstructure research that have not really caught the attention of researchers in India so far are related to the actual transaction process that includes the aspect of transaction cost and its relation with microstructure variables like volume, volatility, open interest, etc. The other important aspect of research is the study of the effects of market microstructure and trading rules on price formation, which includes three critical issues, namely, level of transparency, role of the dealer, and market fragmentation.

While, most studies worldwide have shown that increased transparency in a limit order market results in better liquidity and reduces transaction costs, such research has not yet happened in India.

Initiating such studies will definitely help commodity exchanges as well as regulators to take necessary steps to increase the efficiency of markets. Another aspect for researchers to investigate is the long-term impacts of market microstructure. This involves work on the significance of market microstructure in portfolio selection, information risks, and pricing.

The role of information in pricing is also important here. There is a need for considering popular pricing models like the capital asset pricing model (CAPM), consumption-based CAPM, and arbitrage pricing theory (APT), and ascertain the role of information cost (which increases the cost of transaction).All these important hypotheses need to be tested in the context of Indian commodity markets.

The author is senior vice-president, Takshashila Academia of Economic Research. The views expressed are personal