New Economics Papers
on Market Microstructure
Issue of 2013‒12‒15
seven papers chosen by
Thanos Verousis

  1. The Self-Financing Equation in High Frequency Markets By Rene Carmona; Kevin Webster
  2. The Market Microstructure of the European Climate Exchange By Yoichi Otsubo; Bruce Mizrach
  3. Measuring the Bid-Ask Spreads: Application to the European Union Allowances Futures Market By Yoichi Otsubo
  4. Optimal Trading Strategies as Measures of Market Disequilibrium By Valerii Salov
  5. Noise Trading and the Cross-Section of Index Option Prices By Fabian Irek; Thorsten Lehnert; Nicolas Martelin
  6. Real-Time Forecasting with a Mixed-Frequency VAR By Frank Schorfheide; Dongho Song
  7. Price Discovery of Tokyo-New York Cross-listed Stocks By Yoichi Otsubo

  1. By: Rene Carmona; Kevin Webster
    Abstract: High Frequency Trading (HFT) represents an ever growing proportion of all financial transactions as most markets have now switched to electronic order book systems. The main goal of the paper is to propose continuous time equations which generalize the self-financing relationships of frictionless markets to electronic markets with limit order books. We use NASDAQ ITCH data to identify significant empirical features such as price impact and recovery, rough paths of inventories and vanishing bid-ask spreads. Starting from these features, we identify microscopic identities holding on the trade clock, and through a diffusion limit argument, derive continuous time equations which provide a macroscopic description of properties of the order book. These equations naturally differentiate between trading via limit and market orders. We give several applications (including hedging European options with limit orders, market maker optimal spread choice, and toxicity indexes) to illustrate their impact and how they can be used to the benefit of Low Frequency Traders (LFTs).
    Date: 2013–12
  2. By: Yoichi Otsubo; Bruce Mizrach (LSF)
    Abstract: This paper analyzes the market microstructure of the European Climate Exchange, the largest EU ETS trading venue. The ECX captures 2/3 of the screen traded market in EUA and more than 90% in CER. 2009 Trading volumes total ?22 billion and are growing, with EUA transactions doubling, and CER volume up 61%. Spreads range from ?0:02 to ?0:06 for EUA and from ?0:07 to ?0:18 for CER. Market impact estimates imply that an average trade will move the EUA market by 1.08 euro centimes and the CER market 4.29. Both Granger-Gonzalo and Hasbrouck information shares imply that approximately 90% of price discovery is taking place in the ECX futures market. We find imbalances in the order book help predict returns for up to three days. A simple trading strategy that enters the market long or short when the order imbalance is strong is profitable even after accounting for spreads and market impact.
    Keywords: "Keywords: carbon; market microstructure; bid-ask spread; information share; order imbalance"
    JEL: G13 G32 E44
    Date: 2012
  3. By: Yoichi Otsubo (LSF)
    Abstract: This study provides a case that the Thompson Waller estimator would have downward bias, which has not been carefully discussed in the literature. Such case is that (i) the buy (sell) order tends to follow buy (sell) order and (ii) the price change associated to such orders are small. The upward bias of the TW estimator would be canceled out by the downward bias, and in such case the estimator would perform better than the other absolute price change methods. The application to the European Union Allowances futures contract trading implies that its trading pattern and the price change provide the conditions that reduce the bias of the Thompson-Waller estimator. Lastly, the Madhavan-Richardson-Roomans model is applied to examine the spread component of the market. A dominance of asymmetric information component in the spread is found. The fraction of the spread attributable to that component increases gradually during the observation period.
    Keywords: "carbon; bid-ask spreads; futures market; European Union Allowances;"
    JEL: C13 G12 G13
    Date: 2012
  4. By: Valerii Salov
    Abstract: For classification of the high frequency trading quantities, waiting times, price increments within and between sessions are referred to as the a-, b-, and c-increments. Statistics of the a-b-c-increments are computed for the Time & Sales records posted by the Chicago Mercantile Exchange Group for the futures traded on Globex. The Weibull, Kumaraswamy, Riemann and Hurwitz Zeta, parabolic, Zipf-Mandelbrot distributions are tested for the a- and b-increments. A discrete version of the Fisher-Tippett distribution is suggested for approximating the extreme b-increments. Kolmogorov and Uspenskii classification of stochastic, typical, and chaotic random sequences is reviewed with regard to the futures price limits. Non-parametric L1 and log-likelihood tests are applied to check dependencies between the a- and b-increments. The maximum profit strategies and optimal trading elements are suggested as measures of frequency and magnitude of the market offers and disequilibrium. Empirical cumulative distribution functions of optimal profits are reported. A few classical papers are reviewed with more details in order to trace the origin and foundation of modern finance.
    Date: 2013–12
  5. By: Fabian Irek; Thorsten Lehnert; Nicolas Martelin (LSF)
    Abstract: Traditional financial theory predicts that noise trader sentiment plays no role for the cross-sectional pattern in stock returns and in the cross-section of option prices. However, empirical research is challenging that view and finds evidence that investor sentiment can be predicted to affect the cross-section of stock returns. In the options literature, research suggests that market sentiment correlates contemporaneously with implied volatilities and the risk-neutral skewness, but the causality is unclear. In recent years, there has been plenty of evidence supporting the notion that mutual fund investors can be classified as noise traders and equity fund flows capture noise trader sentiment. In this paper, using daily aggregated US equity fund flows as a measure of noise trader sentiment, we empirically investigate if the cross-section of index option prices is conditional on our beginning-of-period proxy of noise trading. Overall, our results strongly suggest that noise from the stock market is transmitted into the index option market. We find that when noise traders are bearish (bullish) on a particular day, resulting in flows out of (in) US equity funds, implied volatilities of S&P500 index options tend to significantly increase (decrease) on the following day. Furthermore, our findings suggest that the observed increase (decrease) of risk-neutral skewness of index options is caused by bearish (bullish) noise traders active in the equity market. In line with intuition and other evidence, the effects are more pronounced for out-ofthe- money options and short-term options.
    Keywords: Option Prices, Noise Trading, Implied Volatility, Risk-neutral Skewness,Fund Flows.
    JEL: G12 C15
    Date: 2012
  6. By: Frank Schorfheide; Dongho Song
    Abstract: This paper develops a vector autoregression (VAR) for time series which are observed at mixed frequencies - quarterly and monthly. The model is cast in state-space form and estimated with Bayesian methods under a Minnesota-style prior. We show how to evaluate the marginal data density to implement a data-driven hyperparameter selection. Using a real-time data set, we evaluate forecasts from the mixed-frequency VAR and compare them to standard quarterly-frequency VAR and to forecasts from MIDAS regressions. We document the extent to which information that becomes available within the quarter improves the forecasts in real time.
    JEL: C11 C32 C53
    Date: 2013–12
  7. By: Yoichi Otsubo (LSF)
    Abstract: This study examines price discovery of Japanese companies Tokyo-New York cross-listed shares. Kalman ?filter is utilized to estimate partial price adjustment model. By employing Kalman filter, the present research can deal with problem researchers has to confront in order to analyze nonoverlapping markets such as Tokyo and New York with Hasbrouck s information share or Gonzalo-Granger portfolio weights. By modifying the partial price adjustment model to allow different variance on information shock for each market s opening hours, we find that the magnitude of the shocks are larger during Tokyo opening hours. Dynamic measure suggested by Yan and Zivot (2006) shows that NYSE is more efficient in price discovery.
    Keywords: " information shares; international cross-listing; market microstructure; price discovery;"
    JEL: G14 G15
    Date: 2012

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