New Economics Papers
on Market Microstructure
Issue of 2011‒11‒28
three papers chosen by
Thanos Verousis

  1. Trading and Liquidity with Limited Cognition By Biais, Bruno; Hombert, Johan; Weill, Pierre-Olivier
  2. Does Inter-Market Competition Lead to Less Regulation? By Sarah Draus
  3. Estimating Correlated Jumps and Stochastic Volatilities By Jiří Witzany

  1. By: Biais, Bruno (Toulouse School of Economics (CNRS-CRM, IDEI)); Hombert, Johan (HEC Paris); Weill, Pierre-Olivier (University of California and NBER)
    Abstract: We study the reaction of financial markets to aggregate liquidity shocks when traders face cognition limits. While each financial institution recovers from the shock at a random time, the trader representing the institution observes this recovery with a delay, reecting the time it takes to collect and process information about positions, counterparties and risk exposure. Cognition limits lengthen the recovery process. They also imply that traders who find their institution has not yet recovered from the shock place market sell orders, and then progressively buy back at relatively low prices, while simultaneously placing limit orders to sell later when the price will have recovered. This generates round trip trades, which raise trading volume. We compare the case where algorithms enable traders to implement this strategy to that where traders can only place orders when they have completed their information processing task.
    Keywords: Liquidity shock, Limit-orders, Asset pricing and liquidity, Algorithmic trading, Limited cognition, Sticky plans
    JEL: D83 G12
    Date: 2010–12–07
  2. By: Sarah Draus (CSEF)
    Abstract: This paper presents a model to analyze the consequences of competition in order-flow between a profit maximizing stock exchange and an alternative trading platform on the decisions concerning trading fees and listing requirements. Listing requirements, set by the exchange, provide public information on listed firms and contribute to a better liquidity on all trading venues. It is sometimes asserted that competition induces the exchange to lower its level of listing standards compared to a situation in which it is a monopolist, because the trading platform can free-ride on this regulatory activity and compete more aggressively on trading fees. The present analysis shows that this is not always true and depends on the existence and size of gains related to multi market trading. These gains relax competition on trading fees. The higher these gains are, the more the exchange can increase its revenue from listing and trading when it raises its listing standards. For large enough gains from multi-market trading, the exchange is not induced to lower the level of listing standards when a competing trading platform appears. As a second result, this analysis also reveals a cross - subsidization effect between the listing and the trading activity when listing is not competitive. This model yields implications about the fee structures on stock markets, the regulation of listings and the social optimality of competition for volume.
    Keywords: competition in order flow, fragmentation, listing requirements, stock exchanges
    JEL: G10 G18 G12
    Date: 2011–11–14
  3. By: Jiří Witzany (University of Economics, Prague, Czech Republic)
    Abstract: We formulate a bivariate stochastic volatility jump-diffusion model with correlated jumps and volatilities. An MCMC Metropolis-Hastings sampling algorithm is proposed to estimate the model’s parameters and latent state variables (jumps and stochastic volatilities) given observed returns. The methodology is successfully tested on several artificially generated bivariate time series and then on the two most important Czech domestic financial market time series of the FX (CZK/EUR) and stock (PX index) returns. Four bivariate models with and without jumps and/or stochastic volatility are compared using the deviance information criterion (DIC) confirming importance of incorporation of jumps and stochastic volatility into the model.
    Keywords: jump-diffusion, stochastic volatility, MCMC, Value at Risk, Monte Carlo
    JEL: C11 C15 G1
    Date: 2011–11

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