New Economics Papers
on Market Microstructure
Issue of 2009‒02‒28
four papers chosen by
Thanos Verousis

  1. A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market By Dunne, Peter; Hau, Harald; Moore, Michael
  2. Interbank Market Liquidity and Central Bank Intervention By Franklin Allen; Elena Carletti; Douglas Gale
  3. A New Method for Identifying the Effects of Foreign Exchange Interventions By Chih-nan Chen; Tsutomu Watanabe; Tomoyoshi Yabu
  4. Competition between Exchanges: Lessons from the Battle of the Bund By Cantillon, Estelle; Yin, Pai-Ling

  1. By: Dunne, Peter; Hau, Harald; Moore, Michael
    Abstract: Interdealer trading in the European sovereign bond market is characterized by low spreads and high liquidity. This paper examines whether the dealer-customer segment of the market also benefits from low spreads. Customers are smaller banks and buy-side financial institutions who request quotes from primary dealers. They generally do not enjoy access to the interdealer trading platform. Surprisingly, we find that customer trades are on average competitively priced and often occur inside the interdealer spread. Moreover, higher market volatility increases interdealer spreads more than customer spreads. The theoretical part of the paper develops a new dynamic model of dealer intermediation which captures the segmented market structure of the European bond market. The model explains differences in the volatility dependence of interdealer and customer spreads. The predicted inventory dependence of customer trade quality is also confirmed in the data.
    Keywords: Adverse Selection; Dealer Intermediation; Market Segmentation; Spread Determination
    JEL: D4 G14 G2 G24
    Date: 2008–09
  2. By: Franklin Allen; Elena Carletti; Douglas Gale
    Abstract: We develop a simple model of the interbank market where banks trade a long term, safe asset. We show that when there is a lack of opportunities for banks to hedge aggregate and idiosyncratic liquidity shocks, the interbank market is characterized by excessive price volatility. In such a situation, a central bank can implement the constrained efficient allocation by using open market operations to fix the short term interest rate. The model shows also that market freezes, where banks stop trading with each other, can be a feature of the constrained efficient allocation if there is sufficient uncertainty about aggregate liquidity demand compared to idiosyncratic liquidity demand.
    Keywords: interbank market, liquidity, central bank intervention, open market operations
    JEL: G18 G21
    Date: 2009
  3. By: Chih-nan Chen (Research Analyst, Center for Multicultural Mental Health Research, Harvard University (; Tsutomu Watanabe (Institute of Economic Research and Research Center for Price Dynamics, Hitotsubashi University (E-mail:; Tomoyoshi Yabu (Assistant Graduate School of Systems and Information Engineering, University of Tsukuba, and Institute for Monetary and Economic Studies, Bank of Japan (E-mail:
    Abstract: The monetary authorities react even to intraday changes in the exchange rate; however, in most cases, intervention data is available only at a daily frequency. This temporal aggregation makes it difficult to identify the effects of interventions on the exchange rate. We propose a new method based on Markov Chain Monte Carlo simulations to cope with this endogeneity problem: We use "data augmentation" to obtain intraday intervention amounts and then estimate the efficacy of interventions using the augmented data. Applying this method to Japanese data, we find that an intervention of one trillion yen moves the yen/dollar rate by 1.7 percent, which is more than twice as large as the magnitude reported in previous studies applying OLS to daily observations. This shows the quantitative importance of the endogeneity problem due to temporal aggregation.
    Keywords: Foreign exchange intervention, Intraday data, Markov-chain Monte Carlo method, Endogeneity problem, Temporal aggregation
    JEL: C11 C22 F31 F37
    Date: 2009–02
  4. By: Cantillon, Estelle; Yin, Pai-Ling
    Abstract: In a famous episode of financial history which lasted over eight years, the market for the future on the Bund moved entirely from LIFFE, the incumbent London-based derivatives exchange, to DTB, the entering Frankfurt-based exchange. This paper studies the determinants of traders' exchange choice, using a novel panel dataset that contains individual trading firms' membership status at each exchange together with other firms characteristics and pricing, marketing and product portfolio strategies by each exchange. Our data allows us to evaluate different sources of heterogeneity among trading firms and thus distinguish between different explanations for the observed phenomenon. The story the data tells is one of horizontal differentiation and vertical differentiation through liquidity. As a result, DTB attracted a different set of traders than LIFFE, and those traders contributed to the market share reversal.
    Keywords: intermediation; multi-homing; network effects; platform competition; tipping
    JEL: D4
    Date: 2008–07

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