New Economics Papers
on Market Microstructure
Issue of 2008‒12‒21
three papers chosen by
Thanos Verousis

  1. Individual investors and volatility By Foucault, Thierry; Themar, David; Sraer, David
  2. Do prices in the unmediated call auction reflect insider information? - An experimental analysis By Tobias Brünner; Rene Levinsky
  3. Dispersion Trading: Empirical Evidence from U.S. Options Markets By Cara Marshall

  1. By: Foucault, Thierry; Themar, David; Sraer, David
    Abstract: In this paper, the authors test the hypothesis that individual investors contribute to the idiosyncratic volatility of stock returns because they act as noise traders.
    Keywords: Idiosyncratic volatility; Retail investors; Noise trading
    JEL: G11 G12 G14
    Date: 2008–07–01
  2. By: Tobias Brünner (Institut zur Erforschung der wirtschaftlichen Entwicklung, Albert-Ludwigs-Universität); Rene Levinsky (Max Planck Institute of Economics, Jena, Germany)
    Abstract: The unmediated call auction is a useful trading mechanism to aggregate dispersed information. Its ability to incorporate information of a single informed insider, however, is less well understood. We analyse this question by presenting a simple call auction game where both auction prices and limit prices of uninformed traders re?ect potential insider information. The predictions of the model are tested in the laboratory. While an insider improves the call auction outcomes in terms of increasing trading volume, uninformed traders fail to incorporate the (potential) insider information in their limit prices. We also derive an equilibrium relationship between auction returns and transaction costs similar to the relations that can be found in market microstructure models of continuous markets and which are commonly applied to estimate transaction costs. The experiment provides a good environment to assess the usefulness of this method to estimate transaction costs.
    Keywords: call auction, asymmetric information, experiment, market microstructure
    JEL: C92 G14 D82
    Date: 2008–12–08
  3. By: Cara Marshall (Department of Economics, Queens College of the City University of New York)
    Abstract: This paper develops empirical evidence on a relatively new form of trading, known as “dispersion trading,” that is practiced by some quantitatively sophisticated hedge funds and by some proprietary bank trading desks. The results shed light on the efficiency with which U.S. options markets price volatility. Using end-of-day implied volatilities extracted from equity option prices for the stocks that comprise the S&P 500, I calculate the implied volatility of the S&P 500 using a modification of the Markowitz variance equation. I then compare this Markowitz-implied volatility to the implied volatility of the S&P 500 extracted directly from index options on the S&P 500. I then examine these contemporaneous measures of implied volatility for exploitable discrepancies both without transaction costs and with transaction costs. The study covers the period October 31, 2005 through November 1, 2007. I find that, consistent with the claims of dispersion traders, index option implied volatility tends to exceed the Markowitz-implied volatility derivable from the implied volatilities of the index components. Thus, from a trader’s perspective, index option implied volatility tends to be more often “rich” and component volatilities tend to be more often “cheap.” Nevertheless, there are times when the opposite is true, suggesting that potential dispersion trades can run in either direction.
    Keywords: Dispersion trading, implied volatility, volatility trading, correlation trading, hedge funds
    Date: 2008–09

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