New Economics Papers
on Market Microstructure
Issue of 2011‒09‒16
five papers chosen by
Thanos Verousis

  1. Foreign exchange market structure, players and evolution By Michael R. King; Carol Osler; Dagfinn Rime
  2. Generalized Flat-Top Realized Kernel Estimation of Ex-Post Variation of Asset Prices Contaminated by Noise By Rasmus Tangsgaard Varneskov
  3. Optimal liquidation in dark pools By Gökhan Cebiro˜glu; Ulrich Horst
  4. Who Benefits from Regional Trade Agreements? The View from the Stock Market By Christoph Moser; Andrew K. Rose
  5. The Information Improving Channel of Exchange Rate Intervention: How Do Official Announcements Work? By Kentaro Iwatsubo; Satoshi Kawanishi

  1. By: Michael R. King (Richard Ivey School of Business, University of Western Ontario); Carol Osler (Brandeis International Business School, Brandeis University); Dagfinn Rime (Norges Bank (Central Bank of Norway))
    Abstract: Electronic trading has transformed foreign exchange markets over the past decade, and the pace of innovation only accelerates. This formerly opaque market is now fairly transparent and transaction costs are only a fraction of their former level. Entirely new agents have joined the fray, including retail and high-frequency traders, while foreign exchange trading volumes have tripled. Market concentration among dealers has risen reflecting the heavy investments in technology. Undeterred, some new non-bank market participants have begun to make markets, challenging the traditional foreign exchange dealers on their own turf. This paper outlines the players in this market and the structure of their interactions. It also presents new evidence on how that structure has changed over the past two decades. Throughout, it highlights issues relevant to exchange rate modelling.
    Keywords: exchange rates, algorithmic trading, market microstructure, electronic trading, high frequency trading
    JEL: F31 G12 G15 C42 C82
    Date: 2011–08–14
  2. By: Rasmus Tangsgaard Varneskov (Aarhus University and CREATES)
    Abstract: This paper introduces a new class of generalized at-top realized kernels for estimation of quadratic variation in the presence of market microstructure noise that is allowed to exhibit a non-trivial dependence structure and to be correlated with the ecient price process. The estimators in this class are shown to be consistent, asymptotically unbiased, and mixed gaussian with an optimal n^(1/4)-convergence rate. In addition, an ecient and asymptotically normal estimator of the long run variance of the market microstructure noise is provided along with novel and consistent estimators of the asymptotic variance of the at-top realized kernels and of the integrated quarticity, respectively, creating a powerful, unied framework for analyzing quadratic variation. A nite sample correction ensures non-negativity of the at-top realized kernels without a ecting asymptotic properties. Lastly, in an extensive simulation study, important practical issues such as the choice of kernel function and tuning parameters are addressed, the adequacy of the asymptotic distribution in nite samples is assessed, and it is shown that estimators in this class exhibit a superior bias and root mean squared error tradeo relative to competing estimators. The impact of using various realized estimators is illustrated in a small empirical application to noisy high frequency stock market data.
    Keywords: Bias Reduction, Nonparametric Estimation, Market Microstructure Noise, Quadratic Variation.
    JEL: C14 C15 C50
    Date: 2011–09–01
  3. By: Gökhan Cebiro˜glu; Ulrich Horst
    Abstract: We consider a large trader seeking to liquidate a portfolio using both a transparent trading venue and a dark pool. Our model captures the price impact of trading in transparent traditional venues as well as the execution uncertainty of trading in a dark pool. The unique optimal execution strategy uses both venues continuously. The order size in the dark pool can over- or underrepresent the portfolio size depending on adverse selection and the correlation structure of the assets in the portfolio. Introduction a dark pool results in delayed trading at the traditional venue. The appeal of the dark pool is increased by liquidity but reduced by adverse selection. By pushing up prices at the traditional venue and parallel selling in the dark pool, a trader might generate profits; we provide sufficient conditions to rule out such profitable price manipulation strategies.
    Keywords: Dark pools, Optimal liquidation, Adverse selection, Market microstructure, Illiquid markets
    JEL: C02 C61 G11
    Date: 2011–09
  4. By: Christoph Moser; Andrew K. Rose
    Abstract: The effects of Regional Trade Agreements (RTAs) are disputed. In this paper, we assess these effects using capital market data and an event-study approach, using a daily data set covering a thousand announcements spanning over eighty economies and a hundred RTAs over twenty recent years. We measure the effects of news concerning RTAs on the returns of national stock markets, adjusted for international stock market movements. We then link these excess returns to features of the RTA members and the agreements themselves. We find evidence of the natural trading partner hypothesis; stock markets rise more when RTAs are signed between countries that already engage in high volumes of trade. Stock markets also rise more when poorer countries sign RTAs.
    JEL: F10 F13 G14
    Date: 2011–09
  5. By: Kentaro Iwatsubo (Graduate School of Economics, Kobe University); Satoshi Kawanishi (Sophia University)
    Abstract: This paper studies the relationship between official announcements and the effectiveness of foreign exchange interventions in a noisy rational expectations equilibrium model. We show that when heterogeneously informed traders have inaccurate information, an exchange rate is likely to be misaligned from its fundamental value in the presence of noise trades. Then the central bank uses the disclosure of public information to improve the accuracy of private agentsf information and encourage risk-arbitrage thereby enhancing the informativeness of the exchange rate. This effect holds, even when the central bank does not possess superior information to traders, as long as public information is not perfectly correlated with the information of traders. We provide evidence that announced interventions are more effective in periods of high implied volatility, consistent with the theoretical prediction that the implied volatility of the exchange rate is positively correlated with the information inaccuracy of traders and the degree of an exchange rate misalignment.
    Keywords: Foreign exchange intervention, Announcements, Implied volatility
    JEL: F31
    Date: 2011–08

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