New Economics Papers
on Market Microstructure
Issue of 2011‒03‒12
five papers chosen by
Thanos Verousis

  1. How efficiency shapes market impact By J. Doyne Farmer; Austin Gerig; Fabrizio Lillo; Henri Waelbroeck
  2. Belief Dispersion and Order Submission Strategies in the Foreign Exchange Market By Ingrid Lo; Stephen Sapp
  3. Inside Trading, Public Disclosure and Imperfect Competition By Fuzhou Gong; Hong Liu
  4. Effects of Liquidity on the Nondefault Component of Corporate Yield Spreads: Evidence from Intraday Transactions Data By Song Han; Hao Zhou
  5. Estimating a High-Frequency New-Keynesian Phillips Curve By Steffen Ahrens; Stephen Sacht

  1. By: J. Doyne Farmer; Austin Gerig; Fabrizio Lillo; Henri Waelbroeck
    Abstract: We develop a theory for the market impact of large trading orders, which we call metaorders because they are typically split into small pieces and executed incrementally. Market impact is empirically observed to be a concave function of metaorder size, i.e. the impact per share of large metaorders is smaller than that of small metaorders. Within a framework in which informed traders are competitive we derive a fair pricing condition, which says that the average transaction price of the metaorder is equal to the price after trading is completed. We show that at equilibrium the distribution of trading volume adjusts to reflect information, and dictates the shape of the impact function. The resulting theory makes empirically testable predictions for the functional form of both the temporary and permanent components of market impact. Based on a commonly observed asymptotic distribution for the volume of large trades, it says that market impact should increase asymptotically roughly as the square root of size, with average permanent impact relaxing to about two thirds of peak impact.
    Date: 2011–02
  2. By: Ingrid Lo; Stephen Sapp
    Abstract: This paper empirically examines how dispersions across investors beliefs influence traders order submission decisions in the foreign exchange market. Previous research has found that dispersion in traders beliefs regarding future macroeconomic announcements has a significant impact on both price dynamics and trading volume before the announcements in the foreign exchange and other financial markets. However, little is known about how this dispersion impacts traders choice in submitting different types of orders and thus to supply and demand liquidity either before or after such announcements. Since the types of orders submitted by traders at these times are the building blocks of the observed price and trading dynamics, it is important to understand how differences in investors' information sets before and after important macroeconomic announcements affect their order submission decisions. We find that (i) belief dispersion affects the size and aggressiveness of orders both before and after macroeconomic announcements, (ii) the magnitude of the impact of factors known to affect order choice depends on the level of belief dispersion, and (iii) the influence of information shocks (the revelation of unexpected information) on order choices depends on the level of belief dispersion.
    Keywords: Exchange rates; Market structure and pricing
    JEL: D4 G1
    Date: 2011
  3. By: Fuzhou Gong; Hong Liu
    Abstract: In this paper, we present a multi-period trading model in the style of Kyle (1985)'s inside trading model, by assuming that there are at least two insiders in the market with long-lived private information, under the requirement that each insider publicly discloses his stock trades after the fact. Based on this model, we study the influences of "public disclosure" and "competition among insiders" on the trading behaviors of insiders. We find that the "competition among insiders" leads to higher effective price and lower insiders' profits, and the "public disclosure" makes each insider play a mixed strategy in every round except the last one. An interesting find is that as the total number of auctions goes to infinity, the market depth and the trading intensity at the first auction are all constants with the requirement of "public disclosure", while the market depth at the first auction goes to zero and the trading intensity of the first period goes to infinity without the requirement of "public disclosure".Moreover, we give the exact speed of the revelation of the private information, and show that all information is revealed immediately and the market depth goes to infinity immediately as trading happens infinitely frequently.
    Date: 2011–03
  4. By: Song Han (Federal Reserve Board and Hong Kong Institute for Monetary Research); Hao Zhou (Federal Reserve Board)
    Abstract: We estimate the nondefault component of corporate bond yield spreads and examine its relationship with bond liquidity. We measure bond liquidity using intraday transactions data and estimate the default component using the term structure of credit default swaps (CDS) spreads. With swap rate as the risk free rate, the estimated nondefault component is generally moderate but statistically significant for AA-, A-, and BBB-rated bonds and increasing in this order. With Treasury rate as the risk free rate, the estimated nondefault component is the largest in basis points for BBB-rated bonds but, as a fraction of yield spreads, it is the largest for AAA-rated bonds. Controlling for the unobservable firm heterogeneity, we find a positive and significant relationship between the nondefault component and illiquidity for investment-grade bonds but no significant relationship for speculative-grade bonds. We also find that the nondefault component comoves with indicators for macroeconomic conditions.
    Keywords: Corporate Bond Yield Spreads, Credit Default Swaps, Liquidity, CDS-Bond Basis
    JEL: G12 G13 G14
    Date: 2011–01
  5. By: Steffen Ahrens; Stephen Sacht
    Abstract: This paper estimates a high-frequency New Keynesian Phillips curve via the Generalized Method of Moments. Allowing for higher-thanusual frequencies strongly mitigates the well-known problems of smallsample biases and structural breaks. Applying a daily frequency allows us to obtain eventspecific estimates for the Calvo parameter of nominal rigidity - for instance for the recent financial and economic crisis -, which can be easily transformed into their weekly, monthly and quarterly equivalences to be employed for the analysis of eventspecific monetary and fiscal policy. With Argentine data from the end of 2007 to the beginning of 2011, we find the daily Calvo parameter to vary in a very close range around 0.97, which implies averagely fixed prices of approximately 40 days or equivalently one and a half month or a little less than half a quarter. This has strong implication for the modeling of monetary policy analysis since it implies that at a quarterly frequency a flexible price model has to be employed. In the same vein, to analyze monetary policy in a sticky price framework, a monthly model seems more appropriate
    Keywords: Calvo Staggering, High-Frequency NKM, GMM
    JEL: C63 E31
    Date: 2011–03

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