New Economics Papers
on Market Microstructure
Issue of 2009‒01‒03
eight papers chosen by
Thanos Verousis

  2. The interday and intraday patterns of the overnight market - evidence from an electronic platform By Renaud Beaupain; Alain Durré
  3. Does the law of one price hold in international financial markets? Evidence from tick data By Q. Farooq Akram; Dagfinn Rime; Lucio Sarno
  4. Probability of informed trading on the euro overnight market rate - an update By Julien Idier; Stefano Nardelli
  5. Informed Trading, Liquidity Provision, and Stock Selection by Mutual Funds By Zhi Da; Pengjie Gao; Ravi Jagannathan
  6. How Important Is Liquidity Risk for Sovereign Bond Risk Premia? Evidence from the London Stock Exchange By Ron Alquist
  7. The daily and policy-relevant liquidity effects By Daniel L. Thornton
  8. First versus Second-Mover Advantage with Information Asymmetry about the Size of New Markets By Eric Rasmusen; Young-Ro Yoon

  1. By: Sylwia Nowak
    Abstract: This paper examines how news releases, key microstructure features of market activities and crude oil futures returns affect trading frequency in U.S. airline stocks. Using the autoregressive conditional hazard framework of Hamilton and Jorda (2002), we show that on average, trading intensity spikes prior and consequent to macroeconomic announcements, but decreases around firm- specific releases. We find that market microstructure variables have a small yet significant effect on trading frequency, with high trade volume and narrow bid/ask spread inducing higher trading intensity. Strong evidence is provided to indicate that the intraday crude oil futures returns are relevant for modelling the probability of a trade in airline stocks within the next time period.
    JEL: C22 C51 G14
    Date: 2008–11
  2. By: Renaud Beaupain (IESEG School of Management, 3 rue de la Digue, 59000 Lille, France.); Alain Durré (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: This paper examines the interday and intraday dynamics of the euro area overnight money market on the basis of an original set of market activity and liquidity proxies constructed from both pre- and post-trade data. The empirical literature provides extensive evidence supporting the rejection of the martingale hypothesis both between days and within days, primarily for interest rates and volatility. We extend this analysis and investigate the seasonality of market activity and liquidity in a market dominated by utilitarian traders. We provide evidence that the Eurosystem's operational framework and calendar effects cause the observed regular patterns. We additionally show that utilitarian trading intensifies at the turn of the reserve maintenance period. The increased un-certainty associated with greater information asymmetry between market participants when reserve requirements become binding lead to a deterioration of market liquidity. Our analysis additionally turns out to be sensitive to the implementation in March 2004 of structural changes to the operational framework and to the more frequent occurrence of fine-tuning operations since October 2004. JEL Classification: E43, E58, C22, C32.
    Keywords: Overnight money market, Eurosystem's operational framework, seasonality, market microstructure, tick data.
    Date: 2008–12
  3. By: Q. Farooq Akram (Norges Bank (Central Bank of Norway)); Dagfinn Rime (Norges Bank (Central Bank of Norway)); Lucio Sarno (Cass Business School and CEPR)
    Abstract: This paper investigates the validity of the law of one price (LOP) in international financial markets by examining the frequency, size and duration of inter-market price di erentials for borrowing and lending services (`one-way arbitrage'). Using a unique data set for three major capital and foreign exchange markets that covers a period of more than seven months at tick frequency, we nd that the LOP holds on average, but numerous economically signi cant violations of the LOP arise. The duration of these violations is high enough to make it worth- while searching for one-way arbitrage opportunities in order to minimize borrowing costs and/or maximize earnings on given funds. We also document that such opportunities decline with the pace of the market and increase with market volatility.
    Keywords: Law of one price, One-way arbitrage, Foreign exchange microstructure
    JEL: F31 F41 G14 G15
    Date: 2008–11–03
  4. By: Julien Idier (Corresponding author: Banque de France, 39, rue Crois-des-Petits-Champs, F-75049 Paris Cedex 01, France.); Stefano Nardelli (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: In this paper the probability of informed trading (PIN) model developed by Easley and O’Hara (1992) is applied to analyze the role and impact of heterogeneities in euro overnight unsecured market. The empirical assessment of the functioning of this market is based on the PIN which measures the ability of traders to interpret signals on the expected evolution of the overnight rate. Results show that between 2000 and 2004 a heterogeneous learning process of market mechanisms within participants could be observed, whereas such asymmetries have been sharply decreasing since 2005. This is reviewed against some significant events that occurred in the euro money market, such as the reform of the Eurosystem’s operational framework in March 2004 and the recent financial market turmoil, which has represented a break in the steady decline of asymmetries as evidence suggest. JEL Classification: G14, E52.
    Keywords: Microstructure, PIN model, Money Markets.
    Date: 2008–12
  5. By: Zhi Da; Pengjie Gao; Ravi Jagannathan
    Abstract: We show that a mutual fund’s “stock selection skill†computed using the Daniel, Grinblatt, Titman and Wermers (1997) procedure can be decomposed into additional components that include impatient “informed trading†and “liquidity provision,†thereby helping us understand how a fund creates value. We validate our method by verifying that liquidity provision is the dominant component of selection skill for Dimensional Fund Advisors U.S. Micro Cap fund, as observed by Keim (1999). Index funds lose on liquidity absorbing trades, since they pay the price impact on trades triggered by index rebalancing, inflows and redemptions. Consistent with the view that a mutual fund manager with superior stock selection ability is more likely to benefit from trading in stocks affected by information events, we find that funds trading such stocks exhibit superior performance that is more likely to persist. Further, such superior performance comes mostly from impatient informed trading. We also find that informed trading is more important for growth-oriented funds while liquidity provision is more important for younger funds with income orientation.
    JEL: G00 G11 G12 G2
    Date: 2008–12
  6. By: Ron Alquist
    Abstract: This paper uses the framework of arbitrage-pricing theory to study the relationship between liquidity risk and sovereign bond risk premia. The London Stock Exchange in the late 19th century is an ideal laboratory in which to test the proposition that liquidity risk affects the price of sovereign debt. This period was the last time that the debt of a heterogeneous set of countries was traded in a centralized location and that a sufficiently long time series of observable bond prices are available to conduct asset-pricing tests. Empirical analysis of these data establishes three new results. First, sovereign bonds with wide bid-ask spreads earn 3-4% more per year than bonds with narrow bid-ask spreads, and the difference is reflected in greater sensitivity to innovations in market liquidity. Second, small sovereign bonds, as measured by market value, earn 1.8-3.5% more per year than large sovereign bonds, and the difference is also reflected in their exposure to innovations in market liquidity. Third, market liquidity is a state variable important for pricing the cross-section of sovereign bonds. This paper thus provides estimates of the quantitative importance of liquidity risk as a determinant of the sovereign risk premium and underscores the significance of market liquidity as a nondiversifiable risk.
    Keywords: Financial markets; International topics
    JEL: F21 F34 F36 G12 G15
    Date: 2008
  7. By: Daniel L. Thornton (Federal Reserve Bank of St. Louis, 411 Locust St, St Louis, MO, 63166-0442, USA.)
    Abstract: The phrase “liquidity effect” was introduced by Milton Friedman (1969) to describe the first of three effects on interest rates caused by an exogenous change in the money supply. The lack of empirical support for the liquidity effect using monthly and quarterly data using various monetary and reserve aggregates led Hamilton (1997) to suggest that more convincing evidence of the liquidity effect could be obtained using daily data – the daily liquidity effect. This paper investigates the implications of the daily liquidity effect for Friedman’s liquidity effect using a comprehensive model of the Fed’s daily operating procedure. The evidence indicates that it is no easier to find convincing evidence of a Friedman’s liquidity effect using daily data than it has been using lower frequency data. JEL Classification: E40, E52.
    Keywords: liquidity effect, federal funds rate, monetary policy, operating procedure, FOMC.
    Date: 2008–12
  8. By: Eric Rasmusen (Department of Business Economics and Public Policy, Indiana University Kelley School of Business); Young-Ro Yoon (Department of Economics, Indiana University)
    Abstract: Is it better to move first, or second— to innovate, or to imitate? We look at this in a context with both asymmetric information and payoff externalities. Suppose two players, one with superior information about market quality, consider entering one of two new markets immediately or waiting until the last possible date. We show that the more accurate the informed player’s information, the more he wants to delay to keep his information private. The less-informed player also wants to delay, but in order to learn. The less accurate the informed player’s information, the more both players want to move first to foreclose a market. More accurate information can lead to inefficiency by increasing the players’ incentive to delay. Thus, a moderate delay cost can increase industry profits.
    Keywords: market entry, first- and second mover advantage, payoff externalities, informational externalities, endogenous timing
    JEL: D81 D82 L13
    Date: 2008–11

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