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on Market Microstructure |
| By: | Austin Gerig; David Michayluk |
| Abstract: | Traditional market makers are losing their importance as automated systems have largely assumed the role of liquidity provision in markets. We update the model of Glosten and Milgrom (1985) to analyze this new world: we add multiple securities and introduce an automated market maker who uses the relationships between securities to price order flow. This new automated participant transacts the majority of orders, sets prices that are more efficient, and increases informed and decreases uninformed traders' transaction costs. These results can explain the recent dominance of high frequency trading in US markets and the corresponding increase in trading volume and decrease in transaction costs for US stocks. |
| Date: | 2010–07 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1007.2352&r=mst |
| By: | Michael Kearns; Alex Kulesza; Yuriy Nevmyvaka |
| Abstract: | Addressing the ongoing controversy over aggressive high-frequency trading practices in financial markets, we report the results of an extensive empirical study estimating the maximum possible profitability of such practices, and arrive at figures that are surprisingly modest. Our findings highlight the tension between execution costs and trading horizon confronted by high-frequency traders, and provide a controlled and large-scale empirical perspective on the high-frequency debate that has heretofore been absent. Our study employs a number of novel empirical methods, including the simulation of an "omniscient" high-frequency trader who can see the future and act accordingly. |
| Date: | 2010–07 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1007.2593&r=mst |
| By: | Bruce I. Carlin; Shimon Kogan |
| Abstract: | We perform an experimental study of complexity to assess its effect on trading behavior, price volatility, liquidity, and trade efficiency. Subjects were asked to deduce the value of a particular asset from information they were given about the composition and price of several portfolios. Following that, subjects traded with each other anonymously in a well-defined, simple bargaining process. Portfolio problems ranged from requiring simple analysis to more complicated computation. Complexity altered subjects' bidding strategies, decreased liquidity, increased price volatility, and decreased trade efficiency. Female subjects were affected more by complexity (e.g., lower trade frequency), although they achieved higher payoffs in the complex treatment. Our analysis suggests that complexity may be a driver of volatility and liquidity in financial markets and provides novel testable empirical predictions. |
| JEL: | C92 G12 |
| Date: | 2010–07 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:16187&r=mst |
| By: | Alberto Manconi; Massimo Massa; Ayako Yasuda |
| Abstract: | Using a novel data of institutional investors’ bond holdings, we examine a transmission of the crisis of 2007-2008 from the securitized bond market to the corporate bond market via joint ownership of these bonds by investors. We posit that, ceteris paribus, corporate bonds held by investors with high exposure to securitized bonds and liquidity needs experience greater selling pressure and price declines (yield increases) at the onset of the crisis. We further test predictions of a model of dynamic asset liquidation: Investors with large enough future liquidity shocks retain liquid assets, and instead sell assets that have relatively high temporary price impacts of trading. Mutual funds with higher sensitivity of pay to performance held higher portions of their portfolios in securitized bonds prior to the crisis. After the onset of the crisis, these funds did not sell securitized bonds on average and instead sold corporate bonds to meet their liquidity needs. Sales rose and yield spreads widened more for those corporate bonds whose mutual fund holders’ portfolios were more heavily exposed to securitized bonds, compared to same-issuer bonds held by unexposed funds. Shorter-horizon mutual funds liquidated greater portions of their corporate bond holdings and in particular lower-rated bonds. In contrast, insurance companies sold little regardless of their exposure as long as they were above the minimum capital ratio threshold. These findings suggest that short-horizon mutual funds with high exposure to securitized bonds played a role in transmitting the crisis from securitized bonds to corporate bonds. |
| JEL: | G11 G22 G23 G28 |
| Date: | 2010–07 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:16191&r=mst |
| By: | Paresh Kumar Narayan; Zhichao Zhang; Xinwei Zheng |
| Abstract: | In this paper, we examine four specific hypotheses relating to commonality in liquidity on the Chinese stock markets. These hypotheses are: (a) that market-wide liquidity determines liquidity of individual stocks; (b) that liquidity varies with firm size; (c) that sectoral-based liquidity affects individual stock liquidities differently; and (d) that commonality in liquidity has an asymmetric effect. Based on a two-year dataset on the Shanghai and Shenzhen stock exchanges comprising of over 34 and 48 million transactions respectively, we find strong support for commonality in liquidity and a greater influence of industry-wide liquidity in explaining liquidity of individual stocks. Moreover, our results suggest that of the three main sectors – financial, industrial, and resources – industrial sector’s liquidity is most important in explaining individual stock liquidities. Finally, we do not find any evidence of size effects, and document an asymmetric effect of market-wide liquidity on liquidity of individual stocks. |
| Keywords: | Commonality in Liquidity; Asymmetric Information; Size Effects; Chinese Stock Exchange. |
| JEL: | G10 G15 |
| Date: | 2010–07–16 |
| URL: | http://d.repec.org/n?u=RePEc:dkn:econwp:eco_2010_10&r=mst |