New Economics Papers
on Market Microstructure
Issue of 2013‒01‒07
nine papers chosen by
Thanos Verousis

  1. Internalization, Clearing and Settlement, and Liquidity By Degryse, H.A.; Achter, M. van; Wuyts, G.
  2. Sunshine Trading: Flashes of Trading Intent at the NASDAQ By Johannes A. Skjeltorp; Elvira Sojli; Wing Wah Tham
  3. A test for the rank of the volatility process: the random perturbation approach By Jean Jacod; Mark Podolskij
  4. Market structure and exchange rate pass-through By Raphael A. Auer; Raphael S. Schoenle
  5. Liquidity, volatility, and flights to safety in the U.S. treasury market: evidence from a new class of dynamic order book models By Robert Engle; Michael Fleming; Eric Ghysels; Giang Nguyen
  6. The price impact of CDS trading By Gündüz, Yalin; Nasev, Julia; Trapp, Monika
  7. Asymetric Information and the Foreign-Exchange Trades of Global Custody Banks By Carol Osler; Tanseli Savaser; Thang Tan Nguyen
  8. Market Impact with Autocorrelated Order Flow under Perfect Competition By Jonathan Donier
  9. Ownership, control and market liquidity. By Hamon, Jacques; Ginglinger, Edith

  1. By: Degryse, H.A.; Achter, M. van; Wuyts, G. (Tilburg University, Tilburg Law and Economics Center)
    Abstract: Abstract: We study the relation between liquidity in financial markets and post-trading fees (i.e. clearing and settlement fees). The clearing and settlement agent (CSD) faces different marginal costs for different types of transactions. Costs are lower for an internalized transaction, i.e. when buyer and seller originate from the same broker. We study two fee structures that the CSD applies to cover its costs. The first is a uniform fee on all trades (internalized and non-internalized) such that the CSD breaks even on average. Traders then maximize trading rates and higher post-trading fees increase observed liquidity in the market. The second fee structure features a CSD breaking even by charging the internalized and non-internalized trades their respective marginal cost. In this case, traders face the following trade-off: address all possible counterparties at the expense of considerable post-trading fees, or enjoy lower post-trading fees by targeting own-broker counterparties only. This difference in post-trading fees drives traders'strategies and thus liquidity. Furthermore, across the two fee structures, we find that observed liquidity may differ from cum-fee liquidity (which encompasses the post-trading fees). With trade-specific fees, the cum-fee spread depends on the interacting counterparties. Next, regulators can improve welfare by imposing a particular fee structure. The optimal fee structure hinges on the magnitude of the post-trading costs. Noteworthy, a fee structure yielding higher social welfare may in fact reduce observed liquidity. Finally, we consider a number of extensions including market power for the CSD, anonymous trading and differences in broker size.
    Keywords: transaction fees;internalization;clearing and settlement;liquidity;anonymity.
    JEL: G10 G15
    Date: 2012
  2. By: Johannes A. Skjeltorp (Norges Bank); Elvira Sojli (Erasmus University Rotterdam, Duisenberg school of finance); Wing Wah Tham (Erasmus University Rotterdam)
    Abstract: We use the introduction and the subsequent removal of the flash order facility (an actionable indication of interest, IOI) from the NASDAQ as a natural experiment to investigate the impact of voluntary disclosure of trading intent on market quality. We find that flash orders significantly improve liquidity in the NASDAQ. In addition, overall market quality improves substantially when the flash functionality is introduced and deteriorates when it is removed. One explanation for our findings is that flash orders are placed by less informed traders and fulfill their role as an advertisement of uninformed liquidity needs. They successfully attract responses from liquidity providers immediately after the announcement is placed, thus lowering the risk-bearing cost for the overall market. Our study is important in understanding the impact of voluntary disclosure, in guiding future market design choices, and in the current debate on dark pools and IOIs.
    Keywords: Actionable Indication of Interest (IOI); Flash orders; High-frequency Trading
    JEL: G10 G20 G14
    Date: 2012–12–12
  3. By: Jean Jacod (University Paris VI); Mark Podolskij (Heidelberg University and CREATES)
    Abstract: In this paper we present a test for the maximal rank of the matrix-valued volatility process in the continuous Itô semimartingale framework. Our idea is based upon a random perturbation of the original high frequency observations of an Itô semimartingale, which opens the way for rank testing. We develop the complete limit theory for the test statistic and apply it to various null and alternative hypotheses. Finally, we demonstrate a homoscedasticity test for the rank process.
    Keywords: central limit theorem, high frequency data, homoscedasticity testing, Itô semimartingales, rank estimation, stable convergence.
    JEL: C10 C13 C14
    Date: 2012–12–14
  4. By: Raphael A. 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 pass-through. 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 passthrough 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: Price levels
    Date: 2012
  5. By: Robert Engle; Michael Fleming; Eric Ghysels; Giang Nguyen
    Abstract: We propose a new class of dynamic order book models that allow us to 1) study episodes of extreme low liquidity and 2) unite liquidity and volatility in one framework through which their joint dynamics can be examined. Liquidity and volatility in the U.S. Treasury securities market are analyzed around the time of economic announcements, throughout the recent financial crisis, and during flight-to-safety episodes. We document that Treasury market depth declines sharply during the crisis, accompanied by increased price volatility, but that trading activity seems unaffected until after the Lehman Brothers bankruptcy. Our models’ key finding is that price volatility and depth at the best bid and ask prices exhibit a negative feedback relationship and that each becomes more persistent during the crisis. Lastly, we characterize the Treasury market during flights to safety as having much lower market depth, along with higher trading volume and greater price uncertainty.
    Keywords: Liquidity (Economics) ; Government securities ; Treasury bonds ; Financial crises ; Bonds - Prices
    Date: 2012
  6. By: Gündüz, Yalin; Nasev, Julia; Trapp, Monika
    Abstract: In this paper we show that informational and real frictions in CDS markets strongly affect CDS premia. We derive this main finding using a proprietary set of individual CDS transactions cleared by the Depository Trust & Clearing Corporation. We first show that CDS traders adjust the CDS premium in response to the observed order flow. Buy orders lead to an increase of the premium and sell orders to a decrease, suggesting that the order flow carries information. Second, we show that trader adjusts the premium more for transactions with higher inventory risk. Third, we show that the trader adjusts the premium in the way described only if she trades with buyside investors which presumably have less market power. Overall, our results imply that CDS premia contain a significant non-default related component which CDS traders charge to protect themselves against informational and real frictions. --
    Keywords: CDS,frictions,asymmetric information,inventory risk,market power
    JEL: G12 G14
    Date: 2012
  7. By: Carol Osler (International Business School, Brandeis University); Tanseli Savaser (Williams College); Thang Tan Nguyen (International Business School, Brandeis University)
    Abstract: We analyze currency trading between custody banks and their client funds, a trading situation notable for extreme opacity and ongoing legal disputes about reputedly high markups. We propose a “shrouding” model of liquidity provision in which prices are set relative to the day’s extrema to preserve client uncertainty about execution costs. Using the complete 2006 currency trading record of a custody bank, we support this hypothesis with numerous tests. Our analysis of the client funds indicates that they recognize the high costs of standard custodial trades and raises the possibility that they trade through custodians to shroud execution-cost information from underlying investors.
    Keywords: Bid-ask Spread, Exchange Rates, Microstructure, Shrouding, Custody Bank
    JEL: G15
    Date: 2012–11
  8. By: Jonathan Donier
    Abstract: Our goal in this paper is to study the market impact in a market in which the order flow is autocorrelated. We build a model which explains qualitatively and quantitatively the empirical facts observed so far concerning market impact. We define different notions of market impact, and show how they lead to the different price paths observed in the literature. For each one, under the assumption of perfect competition and information, we derive and explain the relationships between the correlations in the order flow, the shape of the market impact function while a meta-order is being executed, and the expected price after the completion. We also derive an expression for the decay of market impact after a trade, and show how it can result in a better liquidation strategy for an informed trader. We show how, in spite of auto-correlation in order-flow, prices can be martingales, and how price manipulation is ruled out even though the bare impact function is concave. We finally assess the cost of market impact and try to make a step towards optimal strategies.
    Date: 2012–12
  9. By: Hamon, Jacques; Ginglinger, Edith
    Abstract: We examine how ownership concentration and the separation of ownership and control affect secondary-market liquidity in France. We find that firms with a large insider blockholder exhibit significantly lower liquidity. However, different methods of enhancing control affect liquidity in different ways. Pyramid structures impair market liquidity. Double voting right shares, a French specific means of control enhancement rewarding long-term shareholders and restraining insiders from trading their shares, lead to increased liquidity, especially for family firms. Our results suggest that by using double voting rights to enhance their control, a transparent decoupling mechanism, rather than pyramids, an opaque decoupling mechanism, blockholders offer higher secondary-market liquidity to outside investors.
    Keywords: Ownership; Blockholders; Long-term shareholders; Ultimate control; Pyramids; Voting rights; Liquidity; Bid-ask spread;
    JEL: G34 G32 G14
    Date: 2012

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