New Economics Papers
on Market Microstructure
Issue of 2012‒12‒22
three papers chosen by
Thanos Verousis

  1. Estimating endogenous liquidity using transaction and order book information By Durand, Philippe; Gündüz, Yalin; Thomazeau, Isabelle
  2. Market Structure and Exchange Rate Pass-Through By Raphael Anton Auer; Raphael S. Schoenle
  3. Disagreement and Asset Prices By Bruce I. Carlin; Francis A. Longstaff; Kyle Matoba

  1. By: Durand, Philippe; Gündüz, Yalin; Thomazeau, Isabelle
    Abstract: We distinguish exogenous liquidity, which corresponds to the variability of bid-ask spreads for usual-sized transactions, from endogenous liquidity, which we interpret as the impact of liquidity on market prices when liquidating larger positions. Endogenous liquidity measures the risk that the realized price of a transaction may be different from the price before the transaction. We apply an endogenous liquidity-based model to order books and credit default swap (CDS) transactions in order to understand two different phenomena. An order book of equity prices has been utilized so as to reveal any 'not yet realized' endogenous liquidity effects, i.e. any effects that become real if a new order is executed. Our results indicate that measuring the impact of the endogenous liquidity on the valuation of the portfolio is quite realistic. Second, we apply our model to a set of CDS transactions in order to find a 'realized' endogenous liquidity component. We conclude that a realized systemic component is not present in realized CDS transactions, probably due to placing of iceberg orders, simply by slicing the large transactions into several small pieces to avoid liquidity constraints: Traders know perfectly where endogenous liquidity starts when they execute their transactions. --
    Keywords: Endogenous Liquidity,Volume Effect,Credit Default Swaps,Order Book
    JEL: G12
    Date: 2012
  2. By: Raphael Anton Auer; Raphael S. Schoenle
    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 passthrough. To this purpose, we evaluate how pass-through rates vary across trade partners and sectors depending on the mass and size distribution of firms affected by a particular exchange rate shock. 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 and that the rate of pass-through following TPC movements is increasing in the trade partner's sector-specific market share. In the second 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 and origins within a sector affects the trade-partner specific pass-through rate. Third, 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 changes and pass-through rates across sectors, trade partners, and sector-trade partner pairs.
    Keywords: Exchange Rate Pass-Through, U.S. Import Prices, Market Structure, Price Complementarities
    JEL: E3 E31 F41
    Date: 2012
  3. By: Bruce I. Carlin; Francis A. Longstaff; Kyle Matoba
    Abstract: How do differences of opinion affect asset prices? Do investors earn a risk premium when disagreement arises in the market? Despite their fundamental importance, these questions are among the most controversial issues in finance. In this paper, we use a novel data set that allows us to directly measure the level of disagreement among Wall Street mortgage dealers about prepayment speeds. We examine how disagreement evolves over time and study its effects on expected returns, return volatility, and trading volume in the mortgage-backed security market. We find that increased disagreement is associated with higher expected returns, higher return volatility, and larger trading volume. These results imply that there is a positive risk premium for disagreement in asset prices. We also show that volatility in and of itself does not lead to higher trading volume. Rather, it is only when disagreement arises in the market that higher uncertainty is associated with more trading. Finally, we are able to distinguish empirically between two competing hypotheses regarding how information in markets gets incorporated into asset prices. We find that sophisticated investors appear to update their beliefs through a rational expectations mechanism when disagreement arises.
    JEL: G12 G14
    Date: 2012–12

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