New Economics Papers
on Market Microstructure
Issue of 2012‒07‒14
three papers chosen by
Thanos Verousis

  1. A dynamic limit order market with fast and slow traders By Hoffmann, Peter
  2. The effectiveness of forex interventions in four latin american countries By Carmen Broto
  3. Regulations and price discovery: oil spot and futures markets By Ashima Goyal; Shruti Tripathi

  1. By: Hoffmann, Peter
    Abstract: We study a dynamic limit order market where agents may invest into a trading technology that grants them a speed advantage over others. Being fast is valuable because it allows limit orders to be revised quickly in the light of new information and therefore reduces the risk of being picked off. Even though this can generate more trading, the equilibrium level of investment is excessive and always generates a welfare loss because fast traders exert negative externalities on slow agents and are able to extract any surplus. If the diffusion of trading technology additionally leads to a more efficient trading process, this result may reverse completely. For sufficiently large efficiency gains, fast traders exert positive externalities on slow market participants and their presence leads to an increase in social welfare, albeit the equilibrium level of investment is below the social optimum. Our results imply that the marginal impact of investments related to algorithmic and high-frequency trading on social welfare crucially depends on the pre-investment level of market efficiency.
    Keywords: Algorithmic Trading; Limit Order Market; Welfare; Investment
    JEL: D62 G19 C72
    Date: 2012–07
  2. By: Carmen Broto (Banco de España)
    Abstract: Many central banks actively intervene in the foreign exchange (forex) market, although there is no consensus on its impact on the exchange rate level and volatility. We analyze the effects of daily forex interventions in four Latin American countries with inflation targets — namely, Chile, Colombia, Mexico and Peru — by fi tting GARCH-type models. These countries represent a broad span of intervention strategies in terms of size and frequency, ranging from pure discretionality to intervention rules. We also provide new evidence on the presence of asymmetries, which arise if foreign currency purchases and sales have different effects on the exchange rate. We find that first interventions, either isolated or initial in a rule, reduce exchange rate volatility, although their size plays a minor role. Our results support the signaling effect of interventions under inflation targeting regimes
    Keywords: Exchange rate volatility; Foreign exchange interventions; GARCH
    JEL: F31 G15 C54
    Date: 2012–07
  3. By: Ashima Goyal (Indira Gandhi Institute of Development Research); Shruti Tripathi (Indira Gandhi Institute of Development Research)
    Abstract: In a period of great oil price volatility, the paper assesses the role of expected net demand compared to liquidity and leverage driven expansion in net long positions. We apply time series tests for mutual and across exchange causality, and lead-lag relationships, between crude oil spot and futures prices on two international and one Indian commodity exchange. We also search for short duration bubbles, and how they differ across exchanges. The results show expectations mediated through financial markets did not lead to persistent deviations from fundamentals. There is mutual Granger causality between spot and futures, and in the error correction model for mature exchanges, spot leads futures. Mature market exchanges lead in price discovery. Futures in these markets lead Indian (daily) futures-markets are integrated. But there is stronger evidence of short-term or collapsing bubbles in mature market futures compared to Indian, although mature markets have a higher share of hedging. Indian regulations such as position limits may have mitigated short duration bubbles. It follows leverage due to lax regulation may be responsible for excess volatility. Well-designed regulations can improve market functioning.
    Keywords: crude oil spot, futures; commodity exchanges; short duration bubbles; position limits
    JEL: G13 G15 G18 E44 C32
    Date: 2012–03

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