New Economics Papers
on Market Microstructure
Issue of 2006‒10‒21
three papers chosen by
Thanos Verousis

  1. The effect of a transaction tax on exchange rate volatility By Lanne , Markku; Vesala , Timo
  2. A wavelet analysis of scaling laws and long-memory in stock market volatility By Vuorenmaa , Tommi
  3. Pricing Implications of Shared Variance in Liquidity Measures By Chollete, Lorán; Næs, Randi; Skjeltorp, Johannes A.

  1. By: Lanne , Markku (Economics Department, European University Institute); Vesala , Timo (RUESG/Department of Economics, University of Helsinki)
    Abstract: We argue that a transaction tax is likely to amplify, not dampen, volatility in the foreign exchange mar-kets. Our argument stems from the decentralised trading practice and the presumable discrepancy be-tween ‘informed’ and ‘uninformed’ traders’ valuations. Since informed traders’ valuations are likely to be less dispersed, a transaction tax penalises informed trades disproportionately, leading to increased volatil-ity. Empirical support for this prediction is found by investigating the effect of transaction costs on the volatility of DEM/USD and JPY/USD returns. High-frequency data are used and an increase in transac-tion costs is found to have a significant positive effect on volatility.
    Keywords: transaction tax; exchange rates; volatility
    JEL: F31 F42 G15 G28
    Date: 2006–10–10
  2. By: Vuorenmaa , Tommi (Department of Economics, University of Helsinki)
    Abstract: This paper investigates the dependence of average stock market volatility on the timescale or on the time interval used to measure price changes, which dependence is often referred to as the scaling law. Scaling factor, on the other hand, refers to the elasticity of the volatility measure with respect to the timescale. This paper studies, in particular, whether the scaling factor differs from the one in a simple random walk model and whether it has remained stable over time. It also explores possible underlying reasons for the observed behaviour of volatility in terms of heterogeneity of stock market players and periodicity of in-traday volatility. The data consist of volatility series of Nokia Oyj at the Helsinki Stock Exchange at five minute frequency over the period from January 4, 1999 to December 30, 2002. The paper uses wavelet methods to decompose stock market volatility at different timescales. Wavelet methods are particularly well motivated in the present context due to their superior ability to describe local properties of times se-ries. The results are, in general, consistent with multiscaling in Finnish stock markets. Furthermore, the scaling factor and the long-memory parameters of the volatility series are not constant over time, nor con-sistent with a random walk model. Interestingly, the evidence also suggests that, for a significant part, the behaviour of volatility is accounted for by an intraday volatility cycle referred to as the New York effect. Long-memory features emerge more clearly in the data over the period around the burst of the IT bubble and may, consequently, be an indication of irrational exuberance on the part of investors.
    Keywords: long-memory; scaling; stock market; volatility; wavelets
    JEL: C14 C22
    Date: 2005–10–11
  3. By: Chollete, Lorán (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration); Næs, Randi (Norges Bank); Skjeltorp, Johannes A. (Norges Bank)
    Abstract: This paper constructs fundamental liquidity measures and investigates the pricing implications of shared variation in a large set of high frequency liquidity measures. Through a common factor analysis we estimate three orthogonal liquidity variables that statistically capture time series variation in market wide liquidity. We uncover three main results. First, we document that not one but two of the common liquidity factors are significantly related to cross-sectional differences in returns. Interestingly, the two factors are related to the time and quantity dimension of liquidity, not the price dimension. Second, and perhaps more striking, we discover substantial heterogeneity in the liquidity factors. In particular, order-based liquidity measures cannot explain return differences while trade-based liquidity measures can explain returns. This heterogeneity is borne out by asset pricing tests, which indicate substantial differences in the pricing of trade and order-based portfolios. Third, there is strong evidence of parameter instability in the pricing of liquidity.
    Keywords: Market microstructure; Common factor; Asset pricing; Liquidity factor; high frequency liquidity
    JEL: G12 G14
    Date: 2006–08–04

This issue is ©2006 by Thanos Verousis. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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