New Economics Papers
on Market Microstructure
Issue of 2007‒04‒21
eight papers chosen by
Thanos Verousis

  1. Price Formation and Liquidity Provision in Short-Term Fixed Income Markets By Chris D'Souza; Ingrid Lo; Stephen Sapp
  2. A Trade-by-Trade Surprise Measure and Its Relation to Observed Spreadson the NYSE By Valeri Voev
  3. Estimating Liquidity Using Information on the Multivariate Trading Process By Katarzyna Bien; Ingmar Nolte; Winfried Pohlmeier
  4. A Multivariate Integer Count Hurdle Model: Theory and Application to Exchange Rate Dynamics By Katarzyna Bien; Ingmar Nolte; Winfried Pohlmeier
  5. Impact of Derivatives Trading on Emerging Capital Markets: A Note on Expiration Day Effects in India By Sumon Bhaumik; Suchismita Bose
  6. Asset Bubbles without Dividends - An Experiment By Jörg Oechssler; Carsten Schmidt; Wendelin Schnedler
  7. Time-Varying Comovements in Developed and Emerging European Stock Markets: Evidence from Intraday Data By Balázs Égert; Evžen Kocenda
  8. US Corporate Default Swap Valuation: The Market Liquidity Hypothesis and Autonomous Credit Risk By Kwamie Dunbar

  1. By: Chris D'Souza; Ingrid Lo; Stephen Sapp
    Abstract: Differences in market structures may affect the manner in which fundamental information is incorporated into prices. High levels of quote and trade transparency plus substantial quoting obligations in European government securities markets ensure that prices are informationally efficient. The relationship between price changes, order flow, relative depth and spreads across European and Canadian short-term government bond markets is examined via a reduced-form vector autoregression model. In European markets, dealers are able to quickly absorb private information elsewhere in the market. Consequently, spreads and the relative depth on the bid and offer sides of the market are found to be only slightly informative. Similarly, order flow, which reflects inventory management practices in addition to private information, explains a smaller proportion of the variation in asset returns in European markets than in Canadian interdealer brokered markets where no quoting obligations exist.
    Keywords: Market structure and pricing; Financial markets; Interest rates
    JEL: G12 G14 G15
    Date: 2007
  2. By: Valeri Voev (University of Konstanz)
    Abstract: We analyze the relationship between spreads and an indicator for information based transactions on trade-by-trade data. Classifying trades on the NYSE in six categories with respect to their volume relative to the quoted depth, we employ an ordered probit model to predict the category of a trade given the current market conditions. This approach allows us to test certain market microstructure hypothesis on the determinants of the buy-sell pressure. The difference between the predicted and the actual trade category (the surprise) is found to have explanatory power for the observed spreads beyond raw volume, volume relative to the quoted depth, and previous trading volume. The positive effect of the previous surprise on the observed spreads confirms the hypothesis that market-makers react to the increased probability of having traded with an informed trader by widening the spread.
    Date: 2006–03–14
  3. By: Katarzyna Bien (University of Konstanz); Ingmar Nolte (University of Konstanz); Winfried Pohlmeier (University of Konstanz)
    Abstract: In this paper we model the dynamic multivariate density of discrete bid and ask quote changes and their associated depths. We account for the contemporaneous relationship between these trading marks by exploiting the concept of copula functions. Thereby we show how to model truncations of the multivariate density in an easy way. A Metropolized-Independence Sampler is applied to draw from the dynamic multivariate density. The samples drawn serve to construct the dynamic density function of the quote slope liquidity measure, which enables us to quantify time varying liquidity risk. We analyze the influence of the decimalization at the NYSE on liquidity.
    Keywords: Liquidity, Copula Functions, Trading Process, Decimalization, Metropolized-Independence Sampler
    JEL: G10 F30 C30
    Date: 2006–03–31
  4. By: Katarzyna Bien (University of Konstanz); Ingmar Nolte (University of Konstanz); Winfried Pohlmeier (University of Konstanz)
    Abstract: In this paper we propose a model for the conditional multivariate density of integer count variables defined on the set Zn. Applying the concept of copula functions, we allow for a general form of dependence between the marginal processes which is able to pick up the complex nonlinear dynamics of multivariate financial time series at high frequencies. We use the model to estimate the conditional bivariate density of the high frequency changes of the EUR/GBP and the EUR/USD exchange rates.
    Keywords: Integer Count Hurdle, Copula Functions, Discrete Multivariate, Distributions, Foreign Exchange Market
    JEL: G10 F30 C30
    Date: 2006–11–14
  5. By: Sumon Bhaumik; Suchismita Bose
    Abstract: The impact of expiration of derivatives contracts on the underlying cash market – on trading volumes, returns and volatility of returns – has been studied in various contexts. We use an AR-GARCH model to analyse the impact of expiration of derivatives contracts on the cash market at the largest stock exchange in India, an important emerging capital market. Our results indicate that trading volumes were significantly higher on expiration days and during the five days leading up to expiration days (“expiration weeks”), compared with nonexpiration days (weeks). We also find significant expiration day effects on daily returns to the market index, and on the volatility of these returns. Finally, our analysis indicates that it might be prudent to undertake analysis of expiration day effects (or other events) using methodologies that model the underlying data generating process, rather than depend on comparison of mean and median alone.
    Keywords: derivatives contracts, expiration day effect, India
    JEL: G14
    Date: 2007–03–01
  6. By: Jörg Oechssler (University of Heidelberg, Department of Economics); Carsten Schmidt (University of Mannheim, Sonderforschungsbereich 504); Wendelin Schnedler (University of Heidelberg, Department of Economics)
    Abstract: Bubbles in asset markets have been documented in numerous experimental studies. However, all experiments in which bubbles occur pay dividends after each trading day. In this paper we study whether bubbles can occur in markets without dividends. We investigate the role of two features that are present in real markets. (1) The mere possibility that some traders may have inside information, and (2) the option to communicate with other traders. We find that bubbles can indeed occur without dividends. Surprisingly, communication turns out to be counterproductive for bubble formation, whereas the possibility of inside information is, as expected, crucial.
    Keywords: asset markets, bubbles, experiment, mirages, dividends
    JEL: C92 G12 D8
    Date: 2007–04
  7. By: Balázs Égert; Evžen Kocenda
    Abstract: We study comovements between three developed (France, Germany, the United Kingdom) and three emerging (the Czech Republic, Hungary and Poland) European stock markets. The novelty of our paper is that we apply the Dynamic Conditional Correlation GARCH models proposed by Engle (2002) to five-minute tick intraday stock price data for the period from June 2003 to January 2006. We find a strong correlation between the German and French markets and also between these two markets and the UK stock market. By contrast, very little systematic positive correlation can be detected between the Western European stock markets and the three stock markets of Central and Eastern Europe, as well as within the latter group.
    Keywords: stock markets, intraday data, comovements, bi-variate GARCH, European integration
    JEL: F37 G15
    Date: 2007–03–01
  8. By: Kwamie Dunbar (University of Connecticut, Stamford, and Sacred Heart University)
    Abstract: This paper develops a reduced form three-factor model which includes a liquidity proxy of market conditions which is then used to provide implicit prices. The model prices are then compared with observed market prices of credit default swaps to determine if swap rates adequately reflect market risks. The findings of the analysis illustrate the importance of liquidity in the valuation process. Moreover, market liquidity, a measure of investors. willingness to commit resources in the credit default swap (CDS) market, was also found to improve the valuation of investors. autonomous credit risk. Thus a failure to include a liquidity proxy could underestimate the implied autonomous credit risk. Autonomous credit risk is defined as the fractional credit risk which does not vary with changes in market risk and liquidity conditions.
    Keywords: Credit Default Swaps; Market Liquidity; Bid-Ask Spreads; Autonomous Credit Risk, Risk Premium
    Date: 2007–01

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