New Economics Papers
on Market Microstructure
Issue of 2011‒04‒09
ten papers chosen by
Thanos Verousis

  1. Intraday patterns in FX returns and order flow By Francis Breedon; Angelo Ranaldo
  2. Intra-Day Seasonality in Foreign Exchange Market Transactions By john cotter; kevin dowd
  3. A semi-Markov model for price returns By Guglielmo D'Amico; Filippo Petroni
  4. Margin setting with high-frequency data1 By John Cotter; Fran\c{c}ois Longin
  5. Trading Directions and the Pricing of Euro Interbank Deposits in the Long Run By Massimiliano Marzo; Paolo Zagaglia
  6. Liquidity considerations in estimating implied volatility By Rohini Grover; Susan Thomas
  7. Arbitrage opportunities between NYSE and XETRA?: A comparison of simulation and high frequency data By Jörg Rieger; Kirsten Rüchardt; Bodo Vogt
  8. Uncovering Long Memory in High Frequency UK Futures By John Cotter
  9. Minimum Capital Requirement Calculations for UK Futures By John Cotter
  10. The tail risks of FX return distributions: a comparison of the returns associated with limit orders and market orders By john cotter; kevin dowd

  1. By: Francis Breedon; Angelo Ranaldo
    Abstract: Using 10 years of high-frequency foreign exchange data, we present evidence of time-of-day effects in foreign exchange returns through a significant tendency for currencies to depreciate during local trading hours. We confirm this pattern across a range of currencies and find that, in the case of EUR/USD, it can form a simple, profitable trading strategy. We also find that this pattern is present in order flow and suggest that both patterns relate to the tendency of market participants to be net purchasers of foreign exchange in their own trading hours. Data from alternative sources appear to corroborate that interpretation.
    Keywords: Foreign Exchange, Microstructure, Order Flow, Liquidity
    JEL: G15
    Date: 2011
  2. By: john cotter; kevin dowd
    Abstract: This paper examines the intra-day seasonality of transacted limit and market orders in the DEM/USD foreign exchange market. Empirical analysis of completed transactions data based on the Dealing 2000-2 electronic inter-dealer broking system indicates significant evidence of intraday seasonality in returns and return volatilities under usual market conditions. Moreover, analysis of realised tail outcomes supports seasonality for extraordinary market conditions across the trading day.
    Date: 2011–03
  3. By: Guglielmo D'Amico; Filippo Petroni
    Abstract: We study the high frequency price dynamics of traded stocks by a model of returns using a semi-Markov approach. More precisely we assume that the intraday return are described by a discrete time homogeneous semi-Markov process and the overnight returns are modeled by a Markov chain. Based on this assumptions we derived the equations for the first passage time distribution and the volatility autocorreletion function. Theoretical results have been compared with empirical findings from real data. In particular we analyzed high frequency data from the Italian stock market from first of January 2007 until end of December 2010. The semi-Markov hypothesis is also tested through a nonparametric test of hypothesis.
    Date: 2011–03
  4. By: John Cotter; Fran\c{c}ois Longin
    Abstract: Both in practice and in the academic literature, models for setting margin requirements in futures markets classically use daily closing price changes. However, as well documented by research on high-frequency data, financial markets have recently shown high intraday volatility, which could bring more risk than expected. This paper tries to answer two questions relevant for margin committees in practice: is it right to compute margin levels based on closing prices and ignoring intraday dynamics? Is it justified to implement intraday margin calls? The paper focuses on the impact of intraday dynamics of market prices on daily margin levels. Daily margin levels are obtained in two ways: first, by using daily price changes defined with different time-intervals (say from 3 pm to 3 pm on the following trading day instead of traditional closing times); second, by using 5-minute and 1-hour price changes and scaling the results to one day. Our empirical analysis uses the FTSE 100 futures contract traded on LIFFE.
    Date: 2011–03
  5. By: Massimiliano Marzo (Department of Economics, Università di Bologna); Paolo Zagaglia (Department of Economics, Università di Bologna)
    Abstract: We investigate the relation between aggregate trading imbalances and interest rates in the Euro money market. We use data for OTC contracts as well as information from the major electronic trading platform in Europe to study the presence of cointegration between trading pressures and money market rates. We report strong evidence of a long-term linear relation between trading imbalances and liquidity prices for Euro interbank deposits.
    Keywords: Euro money market, order flow, interest rates
    JEL: G14 E52
    Date: 2011–03
  6. By: Rohini Grover (Indira Gandhi Institute of Development Research); Susan Thomas (Indira Gandhi Institute of Development Research)
    Abstract: Some option series in the market are far less liquid than others. Market illiquidity can reduce the informativeness of option prices. In this paper, we propose alternative schemes to estimate implied volatility while reducing the importance attached to illiquid options. Using data for index options traded at the National Stock Exchange in India, we and that the performance of a liquidity weighted scheme is superior to that of more conventional schemes such as the vega weights, the volatility elasticity weights and the traditional vxo. Liquidity weights offers the possibility of improved implied volatility estimation in situations where there is strong cross-sectional variation in option market liquidity.
    Keywords: liquidity, implied volatility, volatility index, Indian index options market
    JEL: G12 G13
    Date: 2011–03
  7. By: Jörg Rieger (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg); Kirsten Rüchardt (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg); Bodo Vogt (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg)
    Abstract: This paper investigates both the no-arbitrage condition and the efficiency of financial markets by comparing two stock markets: the New York Stock Exchange (NYSE) and the German Exchange Electronic Trading System (XETRA). We analyze German stocks that are traded simultaneously at both exchanges using high frequency data for XETRA, the NYSE, and the foreign exchange rates. Converting Euro-prices into Dollar-prices reveals possibilities to explore the efficiency as well as arbitrage opportunities of these two stock markets using the phenomenon of stock price clustering. We see the result of differing extents of clustering on both exchanges, thus violating the no-arbitrage condition. We propose a trading strategy that exploits these differences. Furthermore, we compare our empirical findings with the results we obtain from simulating financial markets and conclude that simulations based on the no-arbitrage condition are not consistent with our empirical observations.
    Keywords: financial markets, simulation, no-arbitrage condition, stochastic processes
    JEL: C00 D40 G12
    Date: 2011–03
  8. By: John Cotter
    Abstract: Accurate volatility modelling is paramount for optimal risk management practices. One stylized feature of financial volatility that impacts the modelling process is long memory explored in this paper for alternative risk measures, observed absolute and squared returns for high frequency intraday UK futures. Volatility series for three different asset types, using stock index, interest rate and bond futures are analysed. Long memory is strongest for the bond contract. Long memory is always strongest for the absolute returns series and at a power transformation of k < 1. The long memory findings generally incorporate intraday periodicity. The APARCH model incorporating seven related GARCH processes generally models the futures series adequately documenting ARCH, GARCH and leverage effects.
    Date: 2011–03
  9. By: John Cotter
    Abstract: Key to the imposition of appropriate minimum capital requirements on a daily basis requires accurate volatility estimation. Here, measures are presented based on discrete estimation of aggregated high frequency UK futures realisations underpinned by a continuous time framework. Squared and absolute returns are incorporated into the measurement process so as to rely on the quadratic variation of a diffusion process and be robust in the presence of fat tails. The realized volatility estimates incorporate the long memory property. The dynamics of the volatility variable are adequately captured. Resulting rescaled returns are applied to minimum capital requirement calculations.
    Date: 2011–03
  10. By: john cotter; kevin dowd
    Abstract: This paper measures and compares the tail risks of limit and market orders using Extreme Value Theory. The analysis examines realised tail outcomes using the Dealing 2000-2 electronic broking system based on completed transactions rather than the more common analysis of indicative quotes. In general, limit and market orders exhibit broadly similar tail behaviour, but limit orders have significantly heavier tails and larger tail quantiles than market orders.
    Date: 2011–03

This issue is ©2011 by Thanos Verousis. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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