nep-fmk New Economics Papers
on Financial Markets
Issue of 2017‒08‒27
three papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Systematic Noise: Micro-movements in Equity Options Markets By Adam Wu
  2. Managing Counterparty Risk in OTC Markets By Christoph Frei; Agostino Capponi; Celso Brunetti
  3. Liquidity in the Repo Market By Lucas Marc Fuhrer

  1. By: Adam Wu
    Abstract: Equity options are known to be notoriously difficult to price accurately, and even with the development of established mathematical models there are many assumptions that must be made about the underlying processes driving market movements. As such, the theoretical prices outputted by these models are often slightly different from the realized or actual market price. The choice of model traders use can create many different valuations on the same asset, which may lead to a form of systematic micro-movement or noise. The analysis in this paper demonstrates that approximately 1.7%-4.5% of market volume for options written on the SPY ETF within the last two years could potentially be due to systematic noise.
    Date: 2017–08
  2. By: Christoph Frei; Agostino Capponi; Celso Brunetti
    Abstract: We study how banks manage their default risk before bilaterally negotiating the quantities and prices of over-the-counter (OTC) contracts resembling credit default swaps (CDSs). We show that the costly actions exerted by banks to reduce their default probabilities are not socially optimal. Depending on the imposed trade size limits, risk-management costs and sellers' bargaining power, banks may switch from choosing default risk levels above the social optimum to reducing them even below the social optimum. We use a unique and comprehensive data set of bilateral exposures from the CDS market to test the main model implications on the OTC market structure: (i) intermediation is done by low-risk banks with medium credit exposure; (ii) all banks with high credit exposures are net buyers of CDSs, and low-risk banks with low credit exposures are the main net sellers; and (iii) heterogeneity in post-trade credit exposures is higher for riskier banks and smaller for safer banks.
    Keywords: Over-the-counter markets ; Counterparty risk ; Credit default swaps ; Search
    JEL: G11 G12 G21
    Date: 2017–08–15
  3. By: Lucas Marc Fuhrer
    Abstract: This paper examines liquidity in the Swiss franc repurchase (repo) market and assesses its determinants using a proprietary dataset ranging from 2006 to 2016. I find that repo market liquidity has a distinct intraday pattern, with low liquidity in early and late trading hours. Moreover, repo market liquidity is negatively affected by stress in the global financial system and the end of the minimum reserve requirement period if central bank reserves are scarce. Furthermore, I show that with excess central bank reserves in the financial system, quoted volumes in the interbank market get imbalanced towards more cash provider relative to cash taker quotes and the trading volume declines. By estimating liquidity in an interbank repo market and explaining its drivers, this paper contributes to the ongoing debate on repo market functioning.
    Keywords: Repo market, liquidity, central bank reserves, Switzerland.
    JEL: G01 G12 G21
    Date: 2017

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