nep-mst New Economics Papers
on Market Microstructure
Issue of 2014‒06‒07
five papers chosen by
Thanos Verousis
University of Bath

  1. Factor High-Frequency Based Volatility (HEAVY) Models By Kevin Sheppard
  2. Trading Volume and Market Efficiency: An Agent Based Model with Heterogenous Knowledge about Fundamentals By Vivien Lespagnol; Juliette Rouchier
  3. Integration of a Predictive, Continuous Time Neural Network into Securities Market Trading Operations By Christopher S Kirk
  4. Does the "uptick rule" stabilize the stock market? Insights from Adaptive Rational Equilibrium Dynamics By Fabio Dercole; Davide Radi
  5. Robust pricing and hedging under trading restrictions and the emergence of local martingale models By Alexander M. G. Cox; Zhaoxu Hou; Jan Obloj

  1. By: Kevin Sheppard
    Abstract: �We propose a new class of multivariate volatility models utilizing realized measures of asset volatility and covolatility extracted from high-frequency data. Dimension reduction for estimation of large covariance matrices is achieved by imposing a factor structure with time-varying conditional factor loadings. Statistical properties of the model, including conditions that ensure covariance stationary or returns, are established. The model is applied to modeling the conditional covariance data of large U.S. financial institutions during the financial crisis, where empirical results show that the new model has both superior in- and out-of-sample properties. We show that the superior performance applies to a wide range of quantities of interest, including volatilities, covolatilities, betas and scenario-based risk measures, where the model's performance is particularly strong at short forecast horizons. �
    Keywords: Conditional Beta, Conditional Covariance, Forecasting, HEAVY, Marginal Expected Shortfall, Realized Covariance, Realized Kernel, Systematic Risk
    JEL: C32 C53 C58 G17 G21
    Date: 2014–05–30
  2. By: Vivien Lespagnol (AMSE - Aix-Marseille School of Economics - Centre national de la recherche scientifique (CNRS) - École des Hautes Études en Sciences Sociales (EHESS) - Ecole Centrale Marseille (ECM)); Juliette Rouchier (AMSE - Aix-Marseille School of Economics - Centre national de la recherche scientifique (CNRS) - École des Hautes Études en Sciences Sociales (EHESS) - Ecole Centrale Marseille (ECM))
    Abstract: This paper studies the effect of investor's bounded rationality on market dynamics. In an order driven market, we consider a few-types model where two risky assets are exchanged. Agents differ by their behavior, knowledge, risk aversion and investment horizon. The investor's demand is defined by a utility maximization under constant absolute risk aversion. Relaxing the assumption of perfect knowledge of the fundamentals enables to identify two components in a bubble. The first one comes from the unperceived fundamental changes due to trader's belief perseverance. The second one is generated by chartist behavior. In all simulations, speculators make the market less efficient and more volatile. They also increase the maximum amount of assets exchanged in the most liquid time step. However, our model is not showing raising average volatility on long term. Concerning the fundamentalists, the unknown fundamental has a stabilization impact on the trading price. The closer the anchor is to the true fundamental value, the more efficient the market is, because the prices change smoothly.
    Keywords: agent-based modeling; market microstructure; fundamental value; trading volume; efficient market
    Date: 2014–05
  3. By: Christopher S Kirk
    Abstract: This paper describes recent development and test implementation of a continuous time recurrent neural network that has been configured to predict rates of change in securities. It presents outcomes in the context of popular technical analysis indicators and highlights the potential impact of continuous predictive capability on securities market trading operations.
    Date: 2014–06
  4. By: Fabio Dercole; Davide Radi
    Abstract: This paper investigates the effects of the "uptick rule" (a short selling regulation formally known as rule 10a-1) by means of a simple stock market model, based on the ARED (adaptive rational equilibrium dynamics) modeling framework, where heterogeneous and adaptive beliefs on the future prices of a risky asset were first shown to be responsible for endogenous price fluctuations. The dynamics of stock prices generated by the model, with and without the uptick-rule restriction, are analyzed by pairing the classical fundamental prediction with beliefs based on both linear and nonlinear technical analyses. The comparison shows a reduction of downward price movements of undervalued shares when the short selling restriction is imposed. This gives evidence that the uptick rule meets its intended objective. However, the effects of the short selling regulation fade when the intensity of choice to switch trading strategies is high. The analysis suggests possible side effects of the regulation on price dynamics.
    Date: 2014–05
  5. By: Alexander M. G. Cox; Zhaoxu Hou; Jan Obloj
    Abstract: We consider the pricing of derivatives in a setting with trading restrictions, but without any probabilistic assumptions on the underlying model, in discrete and continuous time. In particular, we assume that European put or call options are traded at certain maturities, and the forward price implied by these option prices may be strictly decreasing in time. In discrete time, when call options are traded, the short-selling restrictions ensure no arbitrage, and we show that classical duality holds between the smallest super-replication price and the supremum over expectations of the payoff over all supermartingale measures. More surprisingly in the case where the only vanilla options are put options, we show that there is a duality gap. Embedding the discrete time model into a continuous time setup, we make a connection with (strict) local-martingale models, and derive framework and results often seen in the literature on financial bubbles. This connection suggests a certain natural interpretation of many existing results in the literature on financial bubbles.
    Date: 2014–06

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