New Economics Papers
on Market Microstructure
Issue of 2014‒07‒28
three papers chosen by
Thanos Verousis

  1. Bid-Ask Spread Components on the Foreign Exchange Market: Quantifying the Risk Component By M. FRÖMMEL; F VAN GYSEGEM
  2. Permutation approach, high frequency trading and variety of micro patterns in financial time series By Cina Aghamohammadi; Mehran Ebrahimian; Hamed Tahmooresi
  3. One-level limit order books with sparsity and memory By Jonathan A. Ch\'avez-Casillas; Jos\'e E. Figueroa-L\'opez

    Abstract: We study the tightness of the complete electronic interbank foreign exchange market for the HUF/ EUR over a two year period. First, we review the cost components that a liquidity provider on this type of market faces, and integrate them in an empirical spread decomposition model. Second, we estimate the bid-ask spread components on an intraday basis, and find that order processing costs account for 47.09% of the spread and that, the combined inventory holding and adverse selection risk component accounts for 52.52% of the spread. In addition, we provide evidence for an endogenous tick size that accounts for one third of the order processing costs and we also estimate the number of liquidity providers based on the risk component. Third, we apply the model to some interesting spread patterns. Using our model we investigate the stylized difference in spreads between peak-times and non-peak times. We find that the combined compensation for inventory holding and adverse selection risk increases during non-peak times, particularly because the risk that a liquidity provider will have to carry an inventory overnight rises. Furthermore, we apply the model to the interesting spread pattern around a speculative attack. Here, credibility of the exchange rate band, competition amongst liquidity providers and increased volatility are key in understanding what happens during this episode of extreme turmoil.
    Keywords: microstructure, foreign exchange, spread, Hungary, inventory, adverse selection, liquidity
    JEL: F31 G15
    Date: 2014–03
  2. By: Cina Aghamohammadi; Mehran Ebrahimian; Hamed Tahmooresi
    Abstract: Permutation approach is suggested as a method to investigate financial time series in micro scales. The method is used to see how high frequency trading in recent years has affected the micro patterns which may be seen in financial time series. Tick to tick exchange rates are considered as examples. It is seen that variety of patterns evolve through time; and that the scale over which the target markets have no dominant patterns, have decreased steadily over time with the emergence of higher frequency trading.
    Date: 2014–07
  3. By: Jonathan A. Ch\'avez-Casillas; Jos\'e E. Figueroa-L\'opez
    Abstract: Motivated by Cont and Larrard (2013)'s seminal Limit Order Book (LOB) model, we propose two continuous-time models for the level I of a LOB in which the arrivals of limit orders, market orders, and cancellations are assumed to be mutually independent, memoryless, and stationary, but, unlike the aforementioned paper, the proposed models also account for some of the sparsity and memory exhibited by real LOB dynamics. Specifically, the first proposed model allows for variable price shifts after each price change in order to account for some of the larger-than-usual "gaps" between levels (sparsity property) that has been observed in some empirical studies. A more realistic approach is pursued in a second model by keeping the information about the standing orders at the opposite side of the book after each price change (memory property), and also incorporating arrivals of new orders within the spread, which in turn leads to a variable spread. In spite of the inherent model complexity, the long-run asymptotic behavior of the resultant mid-price process is fully characterized in both cases and, hence, our analysis shed further light on the relation between the macro price dynamics and some more detailed LOB features than those considered in earlier works. The asymptotic results are illustrated with a numerical Monte Carlo study for which an efficient novel simulation scheme is developed.
    Date: 2014–07

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