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on Market Microstructure |
| By: | Sascha Füllbrunn (Department of Economics, Radboud University Nijmegen); Tibor Neugebauer (Luxembourg School of Finance, Faculty of Law, Economics and Finance, University of Luxembourg) |
| Abstract: | In financial markets, professional traders leverage their trades because it allows to trade larger positions with less margin. Violating margin requirements, however, triggers a margin call and open positions are automatically covered until requirements are met again. What impact does margin trading have on the price process and on liquidity in financial asset markets? Since empirical evidence is mixed, we consider this question using experimental asset markets. Starting from an empirically relevant situation where margin purchasing and short selling is permitted, we ban margin purchases and/or short sales using a 2x2 factorial design to a allow for a comparative static analysis. Our results indicate that a ban on margin purchases fosters efficient pricing by narrowing price deviations from fundamental value accompanied with lower volatility and a smaller bid-ask-spread. A ban on short sales, however, tends to distort efficient pricing by widening price deviations accompanied with higher volatility and a large spread. |
| Keywords: | Leverage, Asset Market, Price Bubble, Experimental Finance |
| JEL: | C92 D70 G12 |
| Date: | 2012–10–19 |
| URL: | http://d.repec.org/n?u=RePEc:jrp:jrpwrp:2012-058&r=mst |
| By: | Christoph K\"uhn; Matthias Riedel |
| Abstract: | We study the price-setting problem of market makers under risk neutrality and perfect competition in continuous time. Thereby we follow the classic Glosten-Milgrom model that defines bid and ask prices as expectations of a true value of the asset given the market makers' partial information that includes the customers trading decisions. The true value is modeled as a Markov process that can be observed by the customers with some noise at Poisson times. We analyze the price-setting problem in a mathematically rigorous way by solving a filtering problem with an endogenous filtration that depends on the bid and ask price process quoted by the market maker. Under some conditions we show existence and uniqueness of the price processes. |
| Date: | 2012–10 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1210.4000&r=mst |
| By: | Wei Sun; Robin Hanson; Kathryn Blackmond Laskey; Charles Twardy |
| Abstract: | A market-maker-based prediction market lets forecasters aggregate information by editing a consensus probability distribution either directly or by trading securities that pay off contingent on an event of interest. Combinatorial prediction markets allow trading on any event that can be specified as a combination of a base set of events. However, explicitly representing the full joint distribution is infeasible for markets with more than a few base events. A factored representation such as a Bayesian network (BN) can achieve tractable computation for problems with many related variables. Standard BN inference algorithms, such as the junction tree algorithm, can be used to update a representation of the entire joint distribution given a change to any local conditional probability. However, in order to let traders reuse assets from prior trades while never allowing assets to become negative, a BN based prediction market also needs to update a representation of each user's assets and find the conditional state in which a user has minimum assets. Users also find it useful to see their expected assets given an edit outcome. We show how to generalize the junction tree algorithm to perform all these computations. |
| Date: | 2012–10 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1210.4900&r=mst |
| By: | Christian Bender |
| Abstract: | We characterize absence of arbitrage with simple trading strategies in a discounted market with a constant bond and several risky assets. We show that if there is a simple arbitrage, then there is a 0-admissible one or an obvious one, that is, a simple arbitrage which promises a minimal riskless gain of \epsilon, if the investor trades at all. For continuous stock models, we provide an equivalent condition for absence of 0-admissible simple arbitrage in terms of a property of the fine structure of the paths, which we call "two-way crossing." This property can be verified for many models by the law of the iterated logarithm. As an application we show that the mixed fractional Black-Scholes model, with Hurst parameter bigger than a half, is free of simple arbitrage on a compact time horizon. More generally, we discuss the absence of simple arbitrage for stochastic volatility models and local volatility models which are perturbed by an independent 1/2-H\"{o}lder continuous process. |
| Date: | 2012–10 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1210.5391&r=mst |
| By: | Gelinde Fellner (Ulm University, Institute of Economics); Sebastian Krügel (Max Planck Institute of Economics, International Max Planck Research School "Uncertainty" and Ulm University) |
| Abstract: | We investigate the theoretically proposed link between judgmental overconfidence and trading activity. In addition to applying classical measures of miscalibration, we introduce a measure to capture misperception of signal reliability, which is the relevant bias in the theoretical overconfidence literature. We relate the obtained overconfidence measures to trading activity in call and continuous experimental asset markets. Our results confirm prior findings that classical miscalibration measures are not related to trading activity. However, misperception of signal reliability is significantly linked to trading volume, particularly in the continuous market. In addition, we find that men trade more than women at high levels of risk aversion, but the gender trading gap vanishes as risk aversion lessens. The reason is that the trading activity of women seems to be more sensitive to risk attitudes than that of men. |
| Keywords: | Overconfidence, Trading activity, Signal perception |
| JEL: | D03 C91 G12 |
| Date: | 2012–10–19 |
| URL: | http://d.repec.org/n?u=RePEc:jrp:jrpwrp:2012-057&r=mst |
| By: | Raphael Schoenle (Brandeis University); Raphael Auer (Swiss National Bank) |
| Abstract: | In this paper, we examine the extent to which market structure and the way in which it affects pricing decisions of profit-maximizing firms can explain incomplete exchange rate pass-through. To this purpose, we evaluate how pass-through rates vary across trade partners and sectors depending on the mass of firms affected by a particular exchange rate shock and the distribution of firms' market shares in the sector. In the first step of our analysis, we decompose bilateral exchange rate movements into broad US Dollar (USD) movements and trade-partner currency (TPC) movements. Using micro data on US import prices, we show that the pass-through rate following USD movements is up to four times as large as the pass-through rate following TPC movements. Second, we show that the rate of pass-through following TPC movements is increasing in the trade partner's sector-specific market share, while the USD pass-through rate is decreasing in the market share of domestic producers. In the third step, we draw on the parsimonious model of oligopoly pricing featuring variable markups of Dornbusch (1987) and Atkeson and Burstein (2008) to show how the distribution of firms' market shares within a sector affects the trade-partner specific TPC pass-through rate. We calibrate this model using our exchange rate decomposition and information on the origin of firms and their market shares. We find that the calibrated model can explain a substantial part of the variation in import price adjustments and pass-through rates across sectors, trade partners, and sector-trade partner pairs. |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed012:61&r=mst |
| By: | Alejandro Bernales; Massimo Guidolin |
| Abstract: | We examine whether the dynamics of the implied volatility surface of individual equity options contains exploitable predictability patterns. Predictability in implied volatilities is expected due to the learning behavior of agents in option markets. In particular, we explore the possibility that the dynamics of the implied volatility surface of individual equity options may be associated with movements in the volatility surface of S&P 500 index options. We present evidence of strong predictable features in the cross-section of equity options and of dynamic linkages between the implied volatility surfaces of equity options and S&P 500 index options. Moreover, time-variations in stock option volatility surfaces are best predicted by incorporating information from the dynamics in the implied volatility surface of S&P 500 index options. We analyze the economic value of such dynamic patterns using strategies that trade straddle and delta-hedged portfolios, and we find that before transaction costs such strategies produce abnormal risk-adjusted returns. |
| Keywords: | Equity options; Index options; Implied volatility surface; Predictability; Trading strategies. JEL Codes: C53, G13, G17. |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:igi:igierp:456&r=mst |