nep-fmk New Economics Papers
on Financial Markets
Issue of 2015‒09‒26
nine papers chosen by

  1. Competition between high-frequency traders, and market quality By Breckenfelder, Johannes
  2. Efficiently Inefficient Markets for Assets and Asset Management By Nicolae B. Gârleanu; Lasse H. Pedersen
  3. Dealer spreads in the corporate bond market: Agent vs. market-making roles By Ederington, Louis; Guan, Wei; Yadav, Pradeep K.
  4. Measuring Contagion-Induced Funding Liquidity Risk in Sovereign Debt Markets By Cho-Hoi Hui; Chi-Fai Lo; Xiao-Fen Zheng; Tom Fong
  5. Capital Markets and Sovereign Defaults: A Historical Perspective By Flores Zendejas, Juan
  6. Could the global financial crisis improve the performance of the G7 stocks markets? By Vieito, João Paulo; Wong, Wing-Keung; Zhu, Zhenzhen
  7. After Dodd-Frank: The Post-Enactment Politics of Financial Reform in the United States By Ziegler, J. Nicholas; Woolley, John T.
  8. Bond markets and monetary policy dilemmas for the emerging markets By Jhuvesh Sobrun; Philip Turner
  9. Towards a History of the Junk Bond Market, 1910-1955 By Peter F. Basile; Sung Won Kang; John Landon-Lane; Hugh Rockoff

  1. By: Breckenfelder, Johannes
    Abstract: This is the first empirical evidence on the competition between high-frequency traders (HFTs) and its influence on market quality. We exploit the first entries of international HFTs into the Swedish equity market in 2009 and conduct a difference-in-differences analysis using trade-by-trade data. To further identify the effect, we use the Federation of European Securities Exchanges (FESE) tick size harmonization as an exogenous event that caused HFTs to start trading in stocks. When HFTs compete for trades their liquidity consumption increases. As a result, liquidity deteriorates significantly and short-term volatility rises.
    Keywords: competition, high-frequency trading, tick size harmonization, FESE, changes in competition
    JEL: G11 G12 G14 G21 G23
    Date: 2013–03
  2. By: Nicolae B. Gârleanu; Lasse H. Pedersen
    Abstract: We consider a model where investors can invest directly or search for an asset manager, information about assets is costly, and managers charge an endogenous fee. The efficiency of asset prices is linked to the efficiency of the asset management market: if investors can find managers more easily, more money is allocated to active management, fees are lower, and asset prices are more efficient. Informed managers outperform after fees, uninformed managers underperform after fees, and the net performance of the average manager depends on the number of "noise allocators." Finally, we show why large investors should be active and discuss broader implications and welfare considerations.
    JEL: D4 D53 D83 G02 G12 G14 G23 L10
    Date: 2015–09
  3. By: Ederington, Louis; Guan, Wei; Yadav, Pradeep K.
    Abstract: Utilizing subsets of trades in which dealers act purely as agents, purely as market-makers, and as both, we decompose dealer spreads in U.S. corporate bond OTC markets into components arising from: 1) dealers' marketmaking role, and 2) their role as agents for their non-dealer customers. We find that agent-related spreads are large and comparable in magnitude to market-making spreads. In their role as agents, dealers face liquidity-search and customer interface costs, while in their role as market makers they face inventory and asymmetric information costs. Consistent with this, we find that while market-making spreads are strongly correlated with market risk variables, agent-related spreads are not, depending instead on liquidity driven variables. While market-making spreads are inversely related to trade size, agent-related spreads increase with trade size before leveling off and then declining - possibly indicating that agent-dealers devote less search time to relatively small trades. Market makers trade both with dealers functioning as agents and directly with investors; our evidence indicates that market makers derive an information benefit from direct interaction with traders especially when risk and information asymmetry is high. Except for very small trades, explicit transaction costs of non-dealer customers are lower when they trade directly with market-making dealers than when they route trades through a dealer acting purely as an agent. Our evidence indicates that bond traders tend to employ agent-dealers when the cost of the agent is low relative to the trader's internal search costs. Finally, we show that many existing studies have underestimated average overall trading costs in the corporate bond market by failing to account for both the agentdealer spread and market-making dealer spread on trades which involve both. Given our findings on the size and economic determinants of agent-related dealer costs, our results have significant implications for the extensive empirical literature on dealer spreads in other OTC markets.
    Keywords: Dealer Spreads,Market-Making Costs,Search Costs
    JEL: G10 G14 G18
    Date: 2015
  4. By: Cho-Hoi Hui (Hong Kong Monetary Authority); Chi-Fai Lo (The Chinese University of Hong Kong); Xiao-Fen Zheng (The Chinese University of Hong Kong); Tom Fong (Hong Kong Monetary Authority)
    Abstract: The euro-area sovereign debt crisis demonstrated how liquidity shocks can build up in a sovereign debt market due to contagion. This paper proposes a model based on the probability density associated with the dynamics of sovereign bond spreads to measure contagion-induced systemic funding liquidity risk in the market. The two risk measures with closed-form formulas derived from the model, are (1) the rate of change of the probability of triggering a liquidity shock determined by the joint sovereign bond spread dynamics of the systemically important countries (i.e., Italy and Spain) and small country (i.e., Portugal); and (2) the distress correlation between bond spreads, which can provide forward-looking signals of such risk. A signal of the rate of change of the joint probability appeared in April 2011 before the liquidity shock occurred in November 2011. There exist endogenous critical levels of sovereign spreads, above which the signal materializes. The empirical results show that when funding cost, risk aversion and equity prices pass through certain levels, the rate of change of the joint probability will rise sharply.
    Keywords: European Sovereign Debt Crisis, Liquidity Risk, Contagion
    JEL: F30 G13
    Date: 2015–08
  5. By: Flores Zendejas, Juan
    Abstract: This paper provides a historical perspective on the relationship between capital markets and sovereign defaults. While the main body of the sovereign debt literature has rarely incorporated supply side factors, such as market distortions or conflicts of interest, we argue that the history of sovereign defaults cannot be understood without including the evolutionary structure of capital markets. The Southern European debt crises and the recent controversy surrounding the role of holdouts demonstrate that certain proposals raised in previous default episodes deserve further discussion, in particular, those aiming to deal with problems of collective action, liquidity provision, and information flaws.
    Keywords: Sovereign defaults, Capital markets, Financial crises
    JEL: G2 F3 F5 N2
    Date: 2015
  6. By: Vieito, João Paulo; Wong, Wing-Keung; Zhu, Zhenzhen
    Abstract: Financial crises are normally associated with negative effects on financial markets. In this paper, we investigate whether the most recent Global Financial Crisis (GFC) had any positive impact on the G7 (Canada, France, Germany, Italy, Japan, the United Kingdom and the United States) indices. We carry out our investigation by employing mean-variance (MV) analysis, CAPM statistics, a runs test, a multiple variation ratio test, and stochastic dominance (SD) tests. Our MV and CAPM results conclude that most of the G7 stock indices are significantly less volatile and have a higher beta, higher Sharpe ratios and a higher Treynor’s index after the GFC. Run tests and multiple variation ratio results confirm that efficiency improved in the post-GFC period. Finally, SD results conclude that there is no arbitrage opportunity and the markets are efficient due to the GFC, and, in general, investors prefer investing in the indices after the GFC. Overall, we conclude that the GFC led to markets that are more efficient and mature, confirming that crises can also have positive impacts on stock markets.
    Keywords: Market Performance; the Global Financial Crisis; Randomness; Market Efficiency; Stochastic Dominance
    JEL: G14 G15
    Date: 2015–09–09
  7. By: Ziegler, J. Nicholas; Woolley, John T.
    Abstract: [first revision] The financial crisis of 2008 raised the politics of regulation to a new level of practical as well as scholarly attention. This paper argues that the post - enactment politics of implementation matter as much to the success of regulatory reform as the politics of passing legislation. In contrast to the prevailing concepts of regulatory capture and business power, we find that recent reform s in U.S. financial markets hinge on intellectual resources and new organizational actors that are missing from existing theories of regulatory change. In particular, small advocacy groups have proven significantly more successful in opposing the financial - services industry than the existing literature predicts. By maintaining the salience of reform goals, elaboratiung new analytic frameworks, and deploying specialized expertise in post - enactment debates, these small organizations have contributed to a diffuse but often decisive network of pro - reform actors. Using empirical material from the rule - writing process for macroprudential supervision and for derivatives trading, we show that these small organizations coalesce with other groups to form a new stability alliance that has prevented industry groups from dominating financial regulation to the degree that occurred in earlier cases of regulatory reform.
    Keywords: Social and Behavioral Sciences
    Date: 2015–08–01
  8. By: Jhuvesh Sobrun; Philip Turner
    Abstract: Financial conditions in the emerging markets (EMs) have become more dependent on the 'world' long-term interest rate, which has been driven down by monetary policies in the advanced economies - notably Quantitative Easing (QE) - and by several non-monetary factors. This paper analyses some new mechanisms that link global long-term rates to monetary policy and to domestic bank lending in the EMs. Understanding these mechanisms could help EM central banks prepare for the exit from QE and higher (and perhaps divergent) policy rates in advanced economies. Although monetary policy in the EMs has continued to be guided by domestic objectives, it has nevertheless lost some traction. Difficult trade-offs now confront central banks.
    Keywords: Exit from QE, long-term interest rate, emerging market economies, bond markets
    Date: 2015–08
  9. By: Peter F. Basile; Sung Won Kang; John Landon-Lane; Hugh Rockoff
    Abstract: We present a new monthly index of the yield on junk (high yield) bonds from 1910-1955. We then use the index to reexamine some of the main debates about the financial history of the interwar years. A close look at junk bond yields: (1) strengthens the view that the decline in lending standards in the late 1920s was modest at best: (2) casts doubt on the view that the banking crisis that began in 1930 disrupted financial markets because banks liquidated their holdings of risky bonds; (3) strengthens the view that the cost of capital rose substantially in the early 1930s and remained high for the rest of the decade; (4) casts doubt on the view that financial markets entered a liquidity trap in the second half of the 1930s; and (5) strengthens the case for believing that junk bond yields contain some information useful for making economic forecasts.
    JEL: N12
    Date: 2015–09

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