New Economics Papers
on Market Microstructure
Issue of 2011‒10‒09
eight papers chosen by
Thanos Verousis

  1. Flat-Top Realized Kernel Estimation of Quadratic Covariation with Non-Synchronous and Noisy Asset Prices By Rasmus Tangsgaard Varneskov
  2. Volatility Forecasting: Downside Risk, Jumps and Leverage Effect By Audrino, Francesco; Hu, Yujia
  3. An analysis of CDS transactions: implications for public reporting By Kathryn Chen; Michael Fleming; John Jackson; Ada Li; Asani Sarkar
  4. A State Space Approach to Estimating the Integrated Variance under the Existence of Market Microstructure Noise By Daisuke Nagakura; Toshiaki Watanabe
  5. The Small and Large Time Implied Volatilities in the Minimal Market Model By Zhi Guo; Eckhard Platen
  6. Double Bubbles in Assets Markets with Multiple Generations By Cary Deck; David Porter; Vernon L. Smith
  7. Estimating a high-frequency New Keynesian Phillips curve By Ahrens, Steffen; Sacht, Stephen
  8. Decomposing short-term return reversal By Zhi Da; Qianqiu Liu; Ernst Schaumburg

  1. By: Rasmus Tangsgaard Varneskov (Aarhus University and CREATES)
    Abstract: This paper extends the class of generalized at-top realized kernels, introduced in Varneskov (2011), to the multivariate case, where quadratic covariation of non-synchronously observed asset prices is estimated in the presence of market microstructure noise that is allowed to exhibit serial dependence and to be correlated with the efficient price process. Estimators in this class are shown to posses desirable statistical properties such as consistency, asymptotic normality, and asymptotic unbiasedness at an optimal n^(1/4)-convergence rate. A finite sample correction based on projections of symmetric matrices ensures positive (semi-)definiteness without altering asymptotic properties of the class of estimators. The finite sample correction admits non-linear transformations of the estimated covariance matrix such as correlations and realized betas, and it can be used in portfolio optimization problems. These transformations are all shown to inherit the desirable asymptotic properties of the generalized at-top realized kernels. A simulation study shows that the class of estimators has a superior finite sample tradeoff between bias and root mean squared error relative to competing estimators. Lastly, two small empirical applications to high frequency stock market data illustrate the bias reduction relative to competing estimators in estimating correlations, realized betas, and mean-variance frontiers, as well as the use of the new estimators in the dynamics of hedging.
    Keywords: Bias Reduction, Nonparametric Estimation, Market Microstructure Noise, Portfolio Optimization, Quadratic Covariation, Realized Beta.
    JEL: C14 C15 G11
    Date: 2011–09–27
  2. By: Audrino, Francesco; Hu, Yujia
    Abstract: We provide new empirical evidence on volatility forecasting in relation to asymmetries present in the dynamics of both return and volatility processes. Leverage and volatility feedback effects among continuous and jump components of the S&P500 price and volatility dynamics are examined using recently developed methodologies to detect jumps and to disentangle their size from continuous return and continuous volatility. Granted that jumps in both return and volatility are important components for generating the two effects, we find jumps in return can improve forecasts of volatility, while jumps in volatility improve volatility forecasts to a lesser extent. Moreover, disentangling jump and continuous variations into signed semivariances further improve the out-of-sample performance of volatility forecasting models, with negative jump semivariance being highly more informative then positive jump semivariance. The model proposed is able to capture many empirical stylized facts while still remaining parsimonious in terms of number of parameters to be estimated.
    Keywords: High frequency data, Realized volatility forecasting, Downside risk, Leverage effect
    JEL: C13 C22 C51 C53
    Date: 2011–09
  3. By: Kathryn Chen; Michael Fleming; John Jackson; Ada Li; Asani Sarkar
    Abstract: Ongoing regulatory reform efforts aim to make the over-the-counter derivatives market more transparent by introducing public reporting of transaction-level information, including price and volume of trades. However, to date there has been a scarcity of data on the structure of trading in this market. This paper analyzes three months of global credit default swap (CDS) transactions and presents findings on the market composition, trading dynamics, and level of standardization. We find that trading activity in the CDS market is relatively low, with a majority of reference entities for single-name CDS trading less than once a day. We also find that a high proportion of CDS transactions conform to standardized contractual and trading conventions. Examining the dealer’s role as market maker, we find that large trades with customers are generally not rapidly offset by further trades in the same reference entity, suggesting that hedging of large positions, if taking place, occurs over a longer time horizon. Through our analysis, we provide a framework for regulators and policymakers to consider the design of the public reporting regime and the necessary improvements to data collection to facilitate meaningful price reporting for credit derivatives.
    Keywords: Credit derivatives ; Disclosure of information ; Hedging (Finance) ; Swaps (Finance) ; Regulatory reform
    Date: 2011
  4. By: Daisuke Nagakura; Toshiaki Watanabe
    Abstract: We call the realized variance (RV), calculated with observed prices contaminated by (market) microstructure noises (MNs), the noise-contaminated RV (NCRV), and refer to the bias component in the NCRV, associated with the MNs, as the MN component. This paper develops a state space method for estimating the integrated variance (IV) and MN component. We represent the NCRV by a state space form and show that the state space form parameters are not identifiable, however, they can be expressed as functions of identifiable parameters. We illustrate how to estimate these parameters. We apply the proposed method to yen/dollar exchange rate data, where we find that most of the variation in NCRV is of the MN component. The proposed method also serves as a convenient way for estimating a general class of continuous-time stochastic volatility (SV) models under the existence of MN.
    Keywords: Realized Variance, Integrated Variance, Microstructure Noise, State Space, Identification, Exchange Rate
    JEL: C13 C22 C53
    Date: 2011–08
  5. By: Zhi Guo; Eckhard Platen
    Abstract: This paper derives explicit formulas for both the small and large time limits of the implied volatility in the minimal market model. It is shown that interest rates do impact on the implied volatility in the long run even though they are negligible in the short time limit.
    Date: 2011–09
  6. By: Cary Deck (Department of Economics, Walton College of Business, University of Arkansas); David Porter (Economic Science Institute, Chapman University); Vernon L. Smith (Economic Science Institute, Chapman University)
    Abstract: We construct an asset market in a finite horizon overlapping-generations environment. Subjects are tested for comprehension of their fundamental value exchange environment, and then reminded during each of 25 periods of its declining new value. We observe price bubbles forming when new generations enter the market with additional liquidity and bursting as old generations exit the market and withdrawing cash. The entry and exit of traders in the market creates an M shaped double bubble price path over the life of the traded asset. This finding is significant in documenting that bubbles can reoccur within one extended trading horizon and, consistent with previous cross-subject comparisons, shows how fluctuations in market liquidity influence price paths. We also find that trading experience leads to price expectations that incorporate fundamental value.
    Keywords: Asset Markets, Price Bubbles, Laboratory Experiments, Overlapping Generations
    JEL: C91 D83 G12
    Date: 2011
  7. By: Ahrens, Steffen; Sacht, Stephen
    Abstract: This paper estimates a high-frequency New Keynesian Phillips curve via the Generalized Method of Moments. Allowing for higher-than-usual frequencies strongly mitigates the well-known problems of small-sample bias and structural breaks. Applying a daily frequency allows us to obtain estimates for the Calvo parameter of nominal rigidity over a very short period - for instance for the recent financial and economic crisis - which can then be easily transformed into their monthly and quarterly equivalences and be employed for the analysis of monetary and fiscal policy. With Argentine data from the end of 2007 to the beginning of 2011, we estimate the daily Calvo parameter and find that on average, prices remain fixed for approximately two to three months which is in line with recent microeconomic evidence. --
    Keywords: Calvo Staggering,High-Frequency NKM,GMM
    JEL: E31
    Date: 2011
  8. By: Zhi Da; Qianqiu Liu; Ernst Schaumburg
    Abstract: The profit to a standard short-term return reversal strategy can be decomposed analytically into four components: 1) across-industry return momentum, 2) within-industry variation in expected returns, 3) under-reaction to within-industry cash flow news, and 4) a residual. Only the residual component, which isolates reaction to recent “nonfundamental” price changes, is significant and positive in the data. A simple short-term return reversal trading strategy designed to capture the residual component generates a highly significant risk-adjusted return three times the size of the standard reversal strategy during our 1982-2009 sampling period. Our decomposition suggests that short-term return reversal is pervasive, much greater than previously documented, and driven by investor sentiment on the short side and liquidity shocks on the long side.
    Keywords: Rate of return ; Liquidity (Economics)
    Date: 2011

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