nep-mst New Economics Papers
on Market Microstructure
Issue of 2010‒05‒29
seven papers chosen by
Thanos Verousis
Swansea University

  1. Forecasting Realized Volatility with Linear and Nonlinear Univariate Models By Michael McAleer; Marcelo C. Medeiros
  2. Intraday Patterns in the Cross-section of Stock Returns By Steven L. Heston; Robert A. Korajczyk; Ronnie Sadka
  3. Modelling and Forecasting Noisy Realized Volatility By Manuabu Asai; Michael McAleer; Marcelo C. Medeiros
  4. Gradual Information Diffusion and Asset Price Momentum By Shengle Lin
  5. Speculation and Hedging in the Currency Futures Markets: Are They Informative to the Spot Exchange Rates By Aaron Tornell; Chunming Yuan
  6. Does Foreign Exchange Reserve Decumulation Lead to Currency Appreciation? By Kathryn M.E. Dominguez; Rasmus Fatum; Pavel Vacek
  7. On the nonlinear influence of Reserve Bank of Australia interventions on exchange rates By Reitz, Stefan; Ruelke, Jan C.; Taylor, Mark P.

  1. By: Michael McAleer (University of Canterbury); Marcelo C. Medeiros
    Abstract: In this paper we consider a nonlinear model based on neural networks as well as linear models to forecast the daily volatility of the S&P 500 and FTSE 100 futures. As a proxy for daily volatility, we consider a consistent and unbiased estimator of the integrated volatility that is computed from high frequency intra-day returns. We also consider a simple algorithm based on bagging (bootstrap aggregation) in order to specify the models analyzed.
    Keywords: Financial econometrics; volatility forecasting; neural networks; nonlinear models; realized volatility; bagging
    Date: 2010–05–01
  2. By: Steven L. Heston; Robert A. Korajczyk; Ronnie Sadka
    Abstract: Motivated by the literature on investment flows and optimal trading, we examine intraday predictability in the cross-section of stock returns. We find a striking pattern of return continuation at half-hour intervals that are exact multiples of a trading day, and this effect lasts for at least 40 trading days. Volume, order imbalance, volatility, and bid-ask spreads exhibit similar patterns, but do not explain the return patterns. We also show that short-term return reversal is driven by temporary liquidity imbalances lasting less than an hour and bid-ask bounce. Timing trades can reduce execution costs by the equivalent of the effective spread.
    Date: 2010–05
  3. By: Manuabu Asai; Michael McAleer (University of Canterbury); Marcelo C. Medeiros
    Abstract: Several methods have recently been proposed in the ultra high frequency financial literature to remove the effects of microstructure noise and to obtain consistent estimates of the integrated volatility (IV) as a measure of ex-post daily volatility. Even bias-corrected and consistent (modified) realized volatility (RV) estimates of the integrated volatility can contain residual microstructure noise and other measurement errors. Such noise is called “realized volatility error”. Since such measurement errors are ignored, we need to take account of them in estimating and forecasting IV. This paper investigates through Monte Carlo simulations the effects of RV errors on estimating and forecasting IV with RV data. It is found that: (i) neglecting RV errors can lead to serious bias in estimators due to model misspecification; (ii) the effects of RV errors on one-step ahead forecasts are minor when consistent estimators are used and when the number of intraday observations is large; and (iii) even the partially corrected recently proposed in the literature should be fully corrected for evaluating forecasts. This paper proposes a full correction of , which can be applied to linear and nonlinear, short and long memory models. An empirical example for S&P 500 data is used to demonstrate that neglecting RV errors can lead to serious bias in estimating the model of integrated volatility, and that the new method proposed here can eliminate the effects of the RV noise. The empirical results also show that the full correction for is necessary for an accurate description of goodness-of-fit.
    Keywords: Realized volatility; diffusion; financial econometrics; measurement errors; forecasting; model evaluation; goodness-of-fit
    Date: 2010–05–01
  4. By: Shengle Lin (Economic Science Institute, Chapman University)
    Abstract: Gradual information diffusion model predicts that as private information travels across the population, pricing accuracy would improve and asset prices would exhibit momentum as a result. In laboratory markets I investigate the market’s aggregation capacity in response to varying proportions of informed traders as a consequence of information diffusion. The results demonstrate that pricing errors are high when private information is dispersed and that, as the information spreads, the market gradually revise the errors and manifest momentum. Analysis suggests that aggregation under dispersed information conditions is hampered by three factors: equilibrium multiplicity, slow arrival of myopic traders, and anonymous trading.
    Date: 2010–01
  5. By: Aaron Tornell (University of California Los Angeles); Chunming Yuan (University of Maryland, Baltimore Couty)
    Abstract: This paper presents an empirical analysis investigating the relationship between the futures trading activities of speculators and hedgers and the potential movements of major spot exchange rates. A set of trader position measures are employed as regression predictors, including the level and change of net positions, an investor sentiment index, extremely bullish/bearish sentiments, and the peak/trough indicators. We find that the peaks and troughs of net positions are generally useful predictors to the evolution of spot exchange rates but other trader position measures are less correlated with future market movements. In addition, speculative position measures usually forecast price-continuations in spot rates while hedging position measures forecast price-reversals in these markets.
    Keywords: Spot Exchange Rates; Currency Futures; Speculation; Hedging; Commitments of Traders
    JEL: F31 F37 G13 G15
    Date: 2009–11–01
  6. By: Kathryn M.E. Dominguez (University of Michigan & NBER); Rasmus Fatum (University of Alberta); Pavel Vacek (University of Alberta)
    Abstract: Many developing countries have increased their foreign reserve stocks dramatically in recent years, in large part motivated by the desire for precautionary self-insurance. One of the negative consequences of large accumulations for these countries is the risk of valuation losses. In this paper we examine the implications of systematic reserve decumulation by the Czech authorities aimed at mitigating valuation losses on euro-denominated assets. The policy was explicitly not intended to influence the value of the koruna relative to the euro. Initially the timing and size of reserve sales was not predictable, eventually sales occurred on a daily basis (in three equal installments within the day). This project examines whether these reserve sales, both during the regime of discretionary timing as well as when sales occurred every day, had unintended consequences for the domestic currency. Our findings using intraday exchange rate data and time-stamped reserve sales indicate that when decumulation occurred every day these sales led to significant appreciation of the koruna. Overall, our results suggest that the manner in which reserve sales are carried out matters for whether reserve decumulation influences the relative value of the domestic currency.
    Keywords: foreign exchange reserves, exchange rate determination, high- frequency volatility modeling
    JEL: E58 F31 F32
    Date: 2010–05
  7. By: Reitz, Stefan; Ruelke, Jan C.; Taylor, Mark P.
    Abstract: This paper applies nonlinear econometric models to empirically investigate the effectiveness of the Reserve Bank of Australia (RBA) exchange rate policy. First, results from a STARTZ model are provided revealing nonlinear mean reversion of the Australian dollar exchange rate in the sense that mean reversion increases with the degree of exchange rate misalignment. Second, a STR-GARCH model suggests that RBA interventions account for this result by strengthening foreign exchange traders' confidence in fundamental analysis. This in line with the so-called coordination channel of intervention effectiveness. --
    Keywords: Foreign exchange intervention,market microstructure,smooth transition,nonlinear mean reversion
    JEL: C10 F31 F41
    Date: 2010

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