New Economics Papers
on Market Microstructure
Issue of 2014‒06‒02
nine papers chosen by
Thanos Verousis

  1. Toxic Arbitrage By Foucault, Thierry; Kozhan, Roman; Tham, Wing Wah
  2. Man or machine? Rational trading without information about fundamentals By Rossi, Stefano; Tinn, Katrin
  3. Do High-Frequency Financial Data Help Forecast Oil Prices? The MIDAS Touch at Work By Baumeister, Christiane; Guérin, Pierre; Kilian, Lutz
  4. Modeling FX market activity around macroeconomic news: a Hawkes process approach By Marcello Rambaldi; Paris Pennesi; Fabrizio Lillo
  5. A high frequency assessment of the ECB Securities Markets Programme By Ghysels, Eric; Idier, Julien; Manganelli, Simone; Vergote, Olivier
  6. Lehman Brothers: What Did Markets Know? By Gehrig, Thomas; Haas, Marlene
  7. Informational asymmetries in laboratory asset markets with state-dependent fundamentals By Keser, Claudia; Markstädter, Andreas
  8. The Media and the Diffusion of Information in Financial Markets: Evidence from Newspaper Strikes By Peress, Joël
  9. Price Distortions in High-Frequency Markets By Steiner, Jakub; Stewart, Colin

  1. By: Foucault, Thierry; Kozhan, Roman; Tham, Wing Wah
    Abstract: High frequency arbitrage opportunities sometimes arise when the price of one asset follows, with a lag, changes in the value of another related asset due to information arrival. These opportunities are toxic because they expose liquidity suppliers to the risk of being picked off by arbitrageurs. Hence, more frequent toxic arbitrage opportunities and a faster arbitrageurs' response to these opportunities impair liquidity. We find support for these predictions using high frequency triangular arbitrage opportunities in the FX market. In our sample, a 1% increase in the likelihood that a toxic arbitrage terminates with an arbitrageur's trade (rather than a quote update) raises bid-ask spreads by about 4%.
    Keywords: Adverse Selection; Arbitrage; High Frequency Trading; Liquidity
    JEL: D50 F31 G10
    Date: 2014–04
  2. By: Rossi, Stefano; Tinn, Katrin
    Abstract: We present a model of quantitative trading as an automated system under human supervision. Contrary to previous literature we show that price-contingent trading is the profitable equilibrium strategy of large rational agents in efficient markets. The key ingredient is uncertainty about whether a large trader is informed about fundamentals. Even when uninformed, he still learns more from prices than market participants who still wonder about whether he is informed. Therefore, he will trade a non-zero quantity based on past prices, whose direction – trend-following or contrarian – depends on parameters. When informed, he will trade on that information and disregard the algorithm. One implication is that future order flow is predictable even if markets are semi-strong efficient by construction.
    Keywords: Kyle model; log-concavity; rational expectations; rational price-contingent trading
    JEL: D82 G12 G14
    Date: 2014–05
  3. By: Baumeister, Christiane; Guérin, Pierre; Kilian, Lutz
    Abstract: The substantial variation in the real price of oil since 2003 has renewed interest in the question of how to forecast monthly and quarterly oil prices. There also has been increased interest in the link between financial markets and oil markets, including the question of whether financial market information helps forecast the real price of oil in physical markets. An obvious advantage of financial data in forecasting oil prices is their availability in real time on a daily or weekly basis. We investigate whether mixed-frequency models may be used to take advantage of these rich data sets. We show that, among a range of alternative high-frequency predictors, especially changes in U.S. crude oil inventories produce substantial and statistically significant real-time improvements in forecast accuracy. The preferred MIDAS model reduces the MSPE by as much as 16 percent compared with the no-change forecast and has statistically significant directional accuracy as high as 82 percent. This MIDAS forecast also is more accurate than a mixed-frequency real-time VAR forecast, but not systematically more accurate than the corresponding forecast based on monthly inventories. We conclude that typically not much is lost by ignoring high-frequency financial data in forecasting the monthly real price of oil.
    Keywords: Forecasts; Mixed frequency; Oil price; Real-time data
    JEL: C53 G14 Q43
    Date: 2013–12
  4. By: Marcello Rambaldi; Paris Pennesi; Fabrizio Lillo
    Abstract: We present a Hawkes model approach to foreign exchange market in which the high frequency price dynamics is affected by a self exciting mechanism and an exogenous component, generated by the pre-announced arrival of macroeconomic news. By focusing on time windows around the news announcement, we find that the model is able to capture the increase of trading activity after the news, both when the news has a sizeable effect on volatility and when this effect is negligible, either because the news in not important or because the announcement is in line with the forecast by analysts. We extend the model by considering non-causal effects, due to the fact that the existence of the news (but not its content) is known by the market before the announcement.
    Date: 2014–05
  5. By: Ghysels, Eric; Idier, Julien; Manganelli, Simone; Vergote, Olivier
    Abstract: Policy impact studies often suffer from endogeneity problems. Consider the case of the ECB Securities Markets Programme. If Eurosystem interventions were triggered by sudden and strong price deteriorations, looking at daily (or weekly) price changes may bias downwards the correlation between yields and the amounts of bonds purchased. Simple regression of daily changes in yields on quantities often give insignificant or even positive coefficients and therefore suggest that SMP interventions have been ineffective, or worse counterproductive. We use high frequency data on purchases of the ECB Securities Markets Programme and sovereign bond quotes to address the endogeneity issues. We propose an econometric model that considers, simultaneously, first and second conditional moments of market price returns at daily and intradaily frequency. Each component of our new econometric model is extended with SMP purchases such that the SMP impact is measured both on yield variations and volatility, and at both daily and intradaily frequency. We find that SMP interventions do not have a significant impact on changes in yields at daily frequency, but when running the same regression with intraday data sampled at 15 minutes interval, we find the expected negative sign. Our empirical investigation reveals also that SMP purchases succeeded in reducing volatility of government bond yields of the countries under the programme. These results are in line with the programme objective of addressing market malfunctioning. Finally, the new econometric model we introduce is of general interest.
    Date: 2013–12
  6. By: Gehrig, Thomas; Haas, Marlene
    Abstract: On September 15, 2008, Lehman Brothers Inc. announced their filing for bankruptcy. The reaction of Lehman's competitors and market participants to this bankruptcy filing announcement provides a unique field experiment of how the insolvency spills over to other financial institutions and how interconnectedness might trigger a financial crisis. Specifically, we analyze transaction prices of major U.S. investment and commercial banks prior to and after the bankruptcy. By decomposing their equity bid-ask spreads, we find evidence that the bankruptcy contributed to increasing adverse selection risk as well as inventory holding risk. Moreover, we find supporting evidence that the degree of competition among market makers did decline. All three components did contribute to a significant rise in transaction costs. Interestingly, the relative contribution of each channel has remained roughly constant. Finally, there is little evidence about insider information within the banking industry just prior to the bankruptcy. In the case of Lehman's stocks the adverse selection component rises in the last days of trading prior to the bankruptcy filing announcement. Moreover, we find no evidence of an increase in the adverse selection component of potential bidders, from which we interpret that the market did not expect a take-over or merger. We explore the robustness of our decomposition by employing volume-synchronized probability of informed trading-measures and impact regressions on prices, quantities, and their respective innovations. In general, we find that information effects are rather short-lived except for the three days prior to the Lehman insolvency.
    Keywords: adverse selection costs; bid ask spreads; contagion; systemic risk
    JEL: D53 G12 G14
    Date: 2014–03
  7. By: Keser, Claudia; Markstädter, Andreas
    Abstract: We investigate the formation of market prices in a new experimental setting involving multi-period call-auction asset markets with state-dependent fundamentals. We are particularly interested in two informational aspects: (1) the role of traders who are informed about the true state and/or (2) the impact of the provision of Bayesian updates of the assets´ state-dependent fundamental values (BFVs) to all traders. We find that bubbles are a rare phenomenon in all of our treatments. Markets with asymmetrically informed traders exhibit smaller price deviations from fundamentals than markets without informed traders. The provision of BFVs has little to no effect. Behavior of informed and uninformed traders differs in early periods but converges over time. On average, uninformed traders offer lower (higher) limit prices and hold less (more) assets than informed traders in good-state (bad-state) markets. Informed traders earn superior profits. --
    Keywords: experimental economics,asset markets,informational asymmetries
    JEL: C92 D53 D82 G14
    Date: 2014
  8. By: Peress, Joël
    Abstract: The media are increasingly recognized as key players in financial markets. I investigate their causal impact on trading and price formation by examining national newspaper strikes in several countries. Trading volume falls 12% on strike days. The dispersion of stock returns and their intraday volatility are reduced by 7%, while aggregate returns are unaffected. Moreover, an analysis of return predictability indicates that newspapers propagate news from the previous day. These findings demonstrate that the media contribute to the efficiency of the stock market by improving the dissemination of information among investors and its incorporation into stock prices.
    Keywords: informational diffusion; market efficiency; media
    JEL: G14
    Date: 2013–09
  9. By: Steiner, Jakub; Stewart, Colin
    Abstract: We study the effect of frequent trading opportunities and categorization on pricing of a risky asset. Frequent opportunities to trade can lead to large distortions in prices if some agents forecast future prices using a simplified model of the world that fails to distinguish between some states. In the limit as the period length vanishes, these distortions take a particular form: the price must be the same in any two states that a positive mass of agents categorize together. Price distortions therefore tend to be large when different agents categorize states in different ways, even if each individual’s categorization is not very coarse. Similar results hold if, instead of using a simplified model of the world, some agents overestimate the likelihood of small probability events, as in prospect theory.
    Keywords: bounded rationality; coarse reasoning; high-frequency trading; price formation
    JEL: D53 D84
    Date: 2014–02

This issue is ©2014 by Thanos Verousis. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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