New Economics Papers
on Market Microstructure
Issue of 2008‒03‒08
four papers chosen by
Thanos Verousis

  1. Frequency of observation and the estimation of integrated volatility in deep and liquid financial markets By Alain Chaboud; Benjamin Chiquoine; Erik Hjalmarsson; Mico Loretan
  2. The Impact of Heterogeneous Trading Rules on the Limit Order Book and Order Flows By Carl Chiarella; Giulia Iori; Josep Perello
  3. Good News is No News By Dijk, D.J.C. van
  4. The Credit Default Swap Market’s Reaction to Earnings Announcements By Caitlin Ann Greatrex

  1. By: Alain Chaboud; Benjamin Chiquoine; Erik Hjalmarsson; Mico Loretan
    Abstract: Using two newly available ultrahigh-frequency datasets, we investigate empirically how frequently one can sample certain foreign exchange and U.S. Treasury security returns without contaminating estimates of their integrated volatility with market microstructure noise. We find that one can sample FX returns as frequently as once every 15 to 20 seconds without contaminating volatility estimates; bond returns may be sampled as frequently as once every 2 to 3 minutes on days without U.S. macroeconomic announcements, and as frequently as once every 40 seconds on announcement days. With a simple realized kernel estimator, the sampling frequencies can be increased to once every 2 to 5 seconds for FX returns and to about once every 30 to 40 seconds for bond returns. These sampling frequencies, especially in the case of FX returns, are much higher than those often recommended in the empirical literature on realized volatility in equity markets. The higher sampling frequencies for FX and bond returns likely reflects the superior depth and liquidity of these markets.
    Keywords: realized volatility, sampling frequency, market microstructure, bond markets, foreign exchange markets, liquidity
    Date: 2008–02
  2. By: Carl Chiarella (School of Finance and Economics University of Technology, Sydney); Giulia Iori (Department of Economics, City University, London); Josep Perello (Departament de Fisica Fonamental, Universitat de Barcelona)
    Abstract: In this paper we develop a model of an order-driven market where traders set bids and asks and post market or limit orders according to exogenously fixed rules. Agents are assumed to have three components to the expectation of future asset returns, namely-fundamentalist, chartist and noise trader. Furthermore agents differ in the characteristics describing these components, such as time horizon, risk aversion and the weights given to the various components. The model developed here extends a great deal of earlier literature in that the order submissions of agents are determined by utility maximisation, rather than the mechanical unit order size that is commonly assumed. In this way the order flow is better related to the ongoing evolution of the market. For the given market structure we analyze the impact of the three components of the trading strategies on the statistical properties of prices and order flows and observe that it is the chartist strategy that is mainly responsible of the fat tails and clustering in the artificial price data generated by the model. The paper provides further evidence that large price changes are likely to be generated by the presence of large gaps in the book.
    Keywords: Market microstructure, limit orders, fundamentalism, chartism, large fluctuations.
    Date: 2008–03
  3. By: Dijk, D.J.C. van (Erasmus Research Institute of Management (ERIM), RSM Erasmus University)
    Abstract: News plays a crucial role in determining prices in financial markets. In an efficient market, current prices fully and correctly reflect all available information, such that only truly new information leads to price adjustment. This lecture shows that using high-frequency data makes it possible to accurately measure the reaction of stock prices on the New York stock exchange to new information related to the Federal funds target rate. An unexpected change in the target rate of 25 basis points leads to a return of slightly more than one percent within five minutes after the news announcement. Furthermore, the effects of positive and negative news on stock prices are fundamentally different. In case of positive news the stock market reaction depends upon the magnitude of the unexpected decrease of the interest rate; in case of negative news, stock prices only respond to the fact that an unexpected rate increase occurs.
    Keywords: Federal funds target rate;monetary announcements;interest rate surprises;high-frequency data;stock return predictability;large data sets;factor analysis;model instability;structural breaks
    Date: 2007–11–15
  4. By: Caitlin Ann Greatrex (Fordham University, Department of Economics)
    Abstract: This paper examines the efficiency of the CDS market by conducting a comparative event study in which both the CDS and the stock markets’ responses to earnings announcements are considered. I find that both markets have statistically significant reactions to earnings announcements and both markets anticipate these informational events up to 90 trading days prior to announcement. I further find that neither markets’ reaction to earnings announcements is entirely efficient as there is evidence of both over- and under-reaction to earnings news. However, results are sensitive to both the categorization of earnings and the model used to generate abnormal performance.
    Keywords: Credit default swap, market efficiency, earnings announcements, credit ratings.
    JEL: G14
    Date: 2008

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