New Economics Papers
on Market Microstructure
Issue of 2008‒05‒31
four papers chosen by
Thanos Verousis

  1. Liquidity and Market Crashes By Jennifer Huang; Jiang Wang
  2. The Risk Components of Liquidity By Chollete, Lorán; Næs, Randi; Skjeltorp, Johannes A.
  3. Market Expectation of Appreciation of the Renminbi By Cho-Hoi Hui; Chi-Fai Lo; Tsz-Kin Chung
  4. The Sources of Volatility Transmission in the Euro Area Money Market: From Longer Maturities to the Overnight? By Zagaglia, Paolo

  1. By: Jennifer Huang; Jiang Wang
    Abstract: In this paper, we develop an equilibrium model for stock market liquidity and its impact on asset prices when constant market presence is costly. We show that even when agents' trading needs are perfectly matched, costly market presence prevents them from synchronizing their trades and hence gives rise to endogenous order imbalances and the need for liquidity. Moreover, the endogenous liquidity need, when it occurs, is characterized by excessive selling of significant magnitudes. Such liquidity-driven selling leads to market crashes in the absence of any aggregate shocks. Finally, we show that illiquidity in the market leads to high expected returns, negative and asymmetric return serial correlation, and a positive relation between trading volume and future returns. We also propose new measures of liquidity based on its asymmetric impact on prices and demonstrate a negative relation between these measures and expected stock returns.
    JEL: E43 E44 G11 G12
    Date: 2008–05
  2. 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: Does liquidity risk differ depending on our choice of liquidity proxy? Unlike literature that considers common liquidity variation, we focus on identifying different components of liquidity, statistically and economically, using more than a decade of US transaction data. We identify three main statistical liquidity factors which are utilized in a linear asset pricing framework. We motivate a correspondence of the statistical factors to traditional dimensions of liquidity as well as the notion of order and trade based liquidity measures. We find evidence of multiple liquidity risk premia, but only a subset of the financial liquidity factors are associated with significant risk premia. These are the factors that we relate to the dimensions of immediacy and resilliency, while the depth dimension does not command a risk premium in any of the models. Our results suggests caution when choosing liquidity variables in asset pricing applications, since liquidity premia may be reflected in only some dimensions of liquidity.
    Keywords: Liquidity Risk; Liquidity Factors; Asset Pricing; Market Microstructure
    JEL: G12 G14
    Date: 2008–03–12
  3. By: Cho-Hoi Hui (Research Department, Hong Kong Monetary Authority); Chi-Fai Lo (Institute of Theoretical Physics and Department of Physics, The Chinese University of Hong Kong); Tsz-Kin Chung (Department of Physics, The Chinese University of Hong Kong)
    Abstract: This paper proposes a path-dependent approach for estimating maximum appreciations of the renminbi expected by the market based on first-passage-time distributions. Using market data of the renminbi spot exchange rates, non-deliverable forward rates and currency option prices from 21 July 2005 (the reform of the exchange rate regime) to 28 February 2008 for model parameters, the maximum appreciations of the renminbi estimated under the proposed approach show that the market expected another large movement of the exchange rate during the 14 months after the reform. Subsequently, the few occasions of appreciations beyond the expected maximums coincided with trade-related issues and speculation that greater momentum of appreciation would be allowed by the authorities. The PBoC¡¦s measures were however largely incorporated into the derivatives¡¦ prices. The proposed approach can be used to gauge the range of appreciations of the renminbi anticipated in the market and to identify any exchange rate movements beyond market expectations.
    Keywords: renminbi exchange rate, first-passage-time distributions, currency options
    JEL: F31 G13
    Date: 2008–04
  4. By: Zagaglia, Paolo (Dept. of Economics, Stockholm University)
    Abstract: This note investigates the transmission of volatility from longer maturities to the overnight segment of the Euro area money market. I use non-parametric estimates of the daily variance of swap rates to test for block exogeneity with respect to the overnight. The results suggest that there exists transmission of volatility shocks from the 1-year swap rate to the overnight market. The reform of the operational framework of March 2004 has improved the segmentation of the market, as it has insulated the overnight segment from spillovers in volatility stemming from swap rates up to 6 months of maturity.
    Keywords: Money Market; High-Frequency Data; Granger Causality
    JEL: C22 E58
    Date: 2008–05–22

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