New Economics Papers
on Market Microstructure
Issue of 2008‒10‒21
six papers chosen by
Thanos Verousis

  1. The partial adjustment factors of FTSE 100 stock index and stock index futures: The informational impact of electronic trading systems By Helder Sebastiãos
  2. The Role of Implied Volatility in Forecasting Future Realized Volatility and Jumps in Foreign Exchange, Stock, and Bond Markets By Thomas Busch; Bent Jesper Christensen; Morten Ørregaard Nielsen
  3. Ranking and Combining Volatility Proxies for Garch and Stochastic Volatility Models By Visser, Marcel P.
  4. Forecasting S&P 500 Daily Volatility using a Proxy for Downward Price Pressure By Visser, Marcel P.
  5. Herding and Contrarianism in a Financial Trading Experiment with Endogenous Timing By Andreas Park; Daniel Sgroi
  6. Price efficiency and speculative trading in cocoa futures markets By Nardella, Michele

  1. By: Helder Sebastiãos (Faculdade de Economia and GEMF, Universidade de Coimbra)
    Abstract: This paper examines the partial adjustment factors of FTSE 100 stock index and stock index futures. Using high frequency data since January 15, 1997 until March 17, 2000, it aims to assess the informational impact of the new electronic trading systems recently implemented at London Stock Exchange and LIFFE. The results suggest that information runs mainly from the futures market to the spot market. We find that the introduction of SETS, in October 1997, has increased the FTSE 100 index absolute efficiency; however it reduced the informational feedback to the futures market. The implementation of LIFFE CONNECT at LIFFE, in May 1999, has reduced the absolute and relative efficiency of FTSE 100 futures. These findings seem to imply that during the period under scrutiny electronic trading has increased the level of microstructural noise, probably due to the bid-ask bounce and order flow imbalances.
    Keywords: Partial adjustments; Price discovery; High frequency data; FTSE 100; Stock index futures; Market microstructure
    JEL: G13 G14 G15
    Date: 2008–10
  2. By: Thomas Busch (Danske Bank and CREATES); Bent Jesper Christensen (University of Aarhus and CREATES); Morten Ørregaard Nielsen (Queen's University and CREATES)
    Abstract: We study the forecasting of future realized volatility in the foreign exchange, stock, and bond markets, and of the separate continuous sample path and jump components of this, from variables in the information set, including implied volatility backed out from option prices. Recent nonparametric statistical techniques of Barndorff-Nielsen & Shephard (2004, 2006) are used to separate realized volatility into its continuous and jump components, which enhances forecasting performance, as shown by Andersen, Bollerslev & Diebold (2007). The heterogeneous autoregressive (HAR) model of Corsi (2004) is applied with implied volatility as an additional forecasting variable, and separating the forecasts of the two realized components. A new vector HAR (VecHAR) model for the resulting simultaneous system is introduced, controlling for possible endogeneity issues. Implied volatility contains incremental information about future volatility in all three markets, even when separating the continuous and jump components of past realized volatility in the information set, and it is an unbiased forecast in the foreign exchange and stock markets. In the foreign exchange market, implied volatility completely subsumes the information content of daily, weekly, and monthly realized volatility measures when forecasting future realized volatility or the continuous or jump component of this. In out-of-sample forecasting experiments, implied volatility alone is the preferred forecast of future realized volatility in all three markets, as mean absolute forecast error increases if realized volatility components are included in the forecast. Perhaps surprisingly, the jump component of realized volatility is, to some extent, predictable, and options appear to be calibrated to incorporate information about future jumps in all three markets.
    Keywords: Bipower variation, HAR, Heterogeneous Autoregressive Model, implied volatility, jumps, options, realized volatility, VecHAR, volatility forecasting
    JEL: C22 C32 F31 G1
    Date: 2008–10
  3. By: Visser, Marcel P.
    Abstract: Daily volatility proxies based on intraday data, such as the high-low range and the realized volatility, are important to the specification of discrete time volatility models, and to the quality of their parameter estimation. The main result of this paper is a simple procedure for combining such proxies into a single, highly efficient volatility proxy. The approach is novel in optimizing proxies in relation to the scale factor (the volatility) in discrete time models, rather than optimizing proxies as estimators of the quadratic variation. For the S&P 500 index tick data over the years 1988-2006 the procedure yields a proxy which puts, among other things, more weight on the sum of the highs than on the sum of the lows over ten-minute intervals. The empirical analysis indicates that this finite-grid optimized proxy outperforms the standard five-minute realized volatility by at least 40%, and the limiting case of the square root of the quadratic variation by 25%.
    Keywords: volatility proxy; realized volatility; quadratic variation; scale factor; arch/garch/stochastic volatility; variance of logarithm
    JEL: G1 C65 C52 C22
    Date: 2008–10–09
  4. By: Visser, Marcel P.
    Abstract: This paper decomposes volatility proxies according to upward and downward price movements in high-frequency financial data, and uses this decomposition for forecasting volatility. The paper introduces a simple Garch-type discrete time model that incorporates such high-frequency based statistics into a forecast equation for daily volatility. Analysis of S&P 500 index tick data over the years 1988-2006 shows that taking into account the downward movements improves forecast accuracy significantly. The R2 statistic for evaluating daily volatility forecasts attains a value of 0.80, both for in-sample and out-of-sample prediction.
    Keywords: volatility proxy; downward absolute power variation; log-Garch; volatility asymmetry; leverage effect; SP500; volatility forecasting; high-frequency data
    JEL: C53 C22 G10
    Date: 2008–10–14
  5. By: Andreas Park; Daniel Sgroi
    Abstract: We undertook the first market trading experiments that allowed heterogeneously informed subjects to trade in endogenous time, collecting over 2000 observed trades. Subjects’ decisions were generally in line with the predictions of exogenous-time financial herding theory when that theory is adjusted to allow rational informational herding and contrarianism. While herding and contrarianism did not arise as frequently as predicted by theory, such behavior occurs in a significantly more pronounced manner than in comparable studies with exogenous timing. Types with extreme information traded earliest. Of those with more moderate information, those with signals conducive to contrarianism traded earlier than those with information conducive to herding.
    Keywords: Herding, Contrarianism, Endogenous-time, Informational Efficiency, Experiments
    JEL: C91 D82 G14
    Date: 2008–10–15
  6. By: Nardella, Michele
    Abstract: In recent years a number of market participants called into question the efficiency of the price discovery mechanism in commodity futures markets. They believe that speculators move commodity futures markets away from their fundamentals by distorting prices and exacerbating volatility. The smoking gun of these allegations is the empirical observation that speculative buying (selling) precedes movements in the cocoa futures markets. Among soft commodities, the cocoa futures market represents an interesting case study. In the last decades, speculators’ open interest is increased by nearly 4 times, fuelling the apprehension of practitioners and market analysts. This paper evaluates the efficiency of the price discovery mechanism in cocoa futures markets. Results show that the price discovery mechanism in both LIFFE and NYBOT cocoa futures markets is efficient. In addition, they rule out the existence of any casual relationship between speculative activity and cocoa prices (i.e. level and volatility) at the least for the NYBOT. This evidence supports the hypothesis that successful speculators are reacting quicker than any other market participant to new information emerging from the market. That is why profitable speculative buying (selling) occurs just before the market makes a move.
    Keywords: futures markets, efficient market hypothesis, speculation, Marketing,
    Date: 2008–01–14

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