New Economics Papers
on Market Microstructure
Issue of 2007‒05‒26
three papers chosen by
Thanos Verousis

  1. Modeling Electronic FX Brokerage as a Fast Order-Driven Marketunder Heterogeneous Private Values and Information By Alexis Derviz
  2. Price Discovery of Credit Spreads for Japanese Mega-Banks: Subordinated Bond and CDS By Naohiko Baba; Masakazu Inada

  1. By: Alexis Derviz (Czech National Bank, Monetary and Statistics Department, Prague, Czech republic; Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic; Institute of Information Theory and Automation, Academy of Sciences of the Czech Republic, Prague, Czech Republic)
    Abstract: The paper develops a theoretical framework for studying price formation in brokered foreign exchange markets with very high order arrival frequency (to be followed by an application to real data on Czech koruna transactions in subsequent work). I construct a model of an order-driven market with very volatile motives for trade and a large number of (nearly) simultaneous limit and market order submissions. The model is applicable to very frequently traded securities such as high-grade bonds or FX. Investors have a non-trivial distribution of private values for the traded asset as well as heterogeneous information about the parameters of this distribution across traders. I investigate the properties of the mapping from the histogram of private asset values and private information endowments to the inside bid and ask price. Basic relationships between the limit order book, market sell and market buy order flow distributions, expected market order execution prices and the probabilities of a limit order execution at a given price, all as functions of private information, are derived. Traders are risk neutral as long as the transacted quantities are small, so that the limit and the market order decisions within one trading round do not feed back into private values. I formulate the equations that characterize the best ask and bid prices in this environment, as well as establish a number of properties of the equilibrium order book.
    Keywords: broker; limit order; market order; market maker; private value; signal
    JEL: G12 G14 G19 G21
    Date: 2007–05
  2. By: Naohiko Baba (Senior Economist and Director, Financial Markets Department, Bank of Japan. (E-mail:; Masakazu Inada (Institute for Monetary and Economic Studies, Bank of Japan. (E-mail:
    Abstract: This paper empirically investigates the determinants of credit spreads for Japanese mega-banks with emphasis on comparing subordinated CDS spreads with the subordinated bond spreads from the viewpoint of price discovery in both credit markets. The main findings are summarized as follows. First, subordinated CDS and subordinated bond spreads are significantly cointegrated for most banks, and price discovery measures suggest that the CDS spread plays a more dominant role in price discovery than the bond spread. Second, although both CDS and bond spreads significantly react to the Japanese sovereign CDS spread, only the CDS spread reacts significantly to other financial market variables including its own volatility and equity return. Third, both spreads are responsive to the changes in fundamental accounting variables such as the capital? asset ratio and the nonperforming loan ratio. These accounting variables are likely to constitute common factors that are behind the cointegration relationship. Last, significant volatility spillovers are detected from the CDS to bond spreads. This result implies that new information flows more in this direction.
    Keywords: Subordinated Bond, Credit Default Swap, Japanese Banks, Price Discovery, Volatility Spillover, Bivariate GARCH
    JEL: G12 G14 G15
    Date: 2007–05
  3. By: Ewald, Christian-Oliver; Xiao, Yajun
    Abstract: We consider a continuous time market model, in which agents influence asset prices. The agents are assumed to be rational and maximizing expected utility from terminal wealth. They share the same utility function but are allowed to possess different levels of information. Technically our model represents a stochastic differential game with anticipative strategy sets. We derive necessary and sufficient criteria for the existence of Nash-equilibria and characterize them for various levels of information asymmetry. Furthermore we study in how far the asymmetry in the level of information influences Nash-equilibria and general welfare. We show that under certain conditions in a competitive environment an increased level of information may in fact lower the level of general welfare. This effect can not be observed in representative agent based models, where information always increases welfare. Finally we extend our model in a way, that we add prior stages, in which agents are allowed to buy and sell information from each other, before engaging in trading with the market assets. We determine equilibrium prices for particular pieces of information in this setup.
    Keywords: information; financial markets; stochastic differential games
    JEL: G14 G11 C73
    Date: 2007

This issue is ©2007 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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