New Economics Papers
on Market Microstructure
Issue of 2008‒02‒09
three papers chosen by
Thanos Verousis

  1. Bid-Ask Spreads and Volume:The Role of Trade Timing By Andreas Park
  2. Dynamic Trading and Asset Prices: Keynes vs. Hayek By Giovanni Cespa; Xavier Vives

  1. By: Andreas Park
    Abstract: I formulate a stylized Glosten-Milgrom model of financial market trading in which people are allowed to time their trading decision. The focus of the analysis is to understand people’s timing behavior and how it affects bid- and offer-prices and volume. Assuming heterogeneous quality of information, not all informed traders choose to trade immediately but some chose to delay, although they expect public expectations to move against them. Compared to a myopic, no-timing setting, first movers with timing have better quality information. Contrary to casual intuition this behavior lowers bid-ask spreads early on and increases them in later periods. Price-variability and total volume in both periods combined decrease. A numerical analysis shows that with timing the spreads are very stable (though decreasing), and that volume is increasing over time. Moreover, with timing the probability of informed trading (PIN) increases between periods.
    Keywords: Microstructure, Sequential Trade, Trade timing.
    JEL: C70 D80 D82 D84 G14
    Date: 2008–01–30
  2. By: Giovanni Cespa (Queen Mary University of London, Università di Salerno, CSEF and CEPR); Xavier Vives (IESE Business School and UPF)
    Abstract: We investigate the dynamics of prices, information and expectations in a competitive, noisy, dynamic asset pricing equilibrium model. We look at the bias of prices as estimators of fundamental value in relation to traders' average expectations and note that prices are more (less) biased than average expectations if and only if traders over- (under-) rely on public information with respect to optimal statistical weights. We find that prices are biased in relation to average expectations whenever traders speculate on short-run price move- ments. In a market with long term traders, over-reliance on public information obtains if noise trade increments are correlated enough and/or there is low enough residual uncertainty in the payoff. This defines a “Keynesian” region; the complementary region is “Hayekian” in that prices are less biased than average expectations in the estimation of fundamental value. The standard case of no residual uncertainty and noise trading following a random walk is on the frontier of the two regions. With short-term traders there typically are two equilibria, with the stable (unstable) one displaying over- (under-) reliance on public information.
    Keywords: Price bias, long and short-term trading, multiple equilibria, average expectations, higher order beliefs, over-reliance on public information.
    JEL: G10 G12 G14
    Date: 2008–01–01
  3. By: Nwaobi, Godwin
    Abstract: Indeed, the specification of equilibrium in the world economy depends on the exchange rate regime and thus, the early contributions to the postwar literature on exchange rate economics are to a large extent concerened with the role of speculation in foreign exchange markets. However, the world has known several exchange rate systems beginning with the fixed-gold standard, the adjustable-peg system, adjustable-parity system and the flexible exchange rate system. Yet, in 1997, when foreign exchange was deregulated, independent traders finally had access to the biggest trading market of the world; and these forex traders attempt to make money from the simultaneous buying and selling of foreign currencies. And within the forex market, many types of instruments can be used:futures market,spot market, and forward market.However, the degree of volatility tends to increase with the frequency with which observations are sampled and this can be seen clearly as one moves from monthly to daily observations on exchange rates. Thus the basic thrust of the paper is to analyse the forecasting accuracy of the full vector autoregressive(FVAR), mixed vector autoregressive(MVAR) and Bayesian vector autoregressive(BVAR) models of the selected currency pairs(based on the monetary/asset model of exchange rate determination).
    Keywords: exchange rate; foreign exchange; forex; forecasting; vector autoregression; regimes; volatility; world;future markets; spotmarket;futures; options; assets; portfolio balance; brettonwood; IMF; Fixed rate; Floating rate; adjustable peg; purchasing power parity(PPP); Uncovered interest rate parity(UIP); internal balance; external balance; devaluation; overvaluation; pips; currency pairs; trading platform; forex allocation; parallel(black) market; banks; brokers; misalignment
    JEL: F00 F37 G1 C53 E42 G15 E44 F31
    Date: 2008–02–01

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