nep-mst New Economics Papers
on Market Microstructure
Issue of 2014‒08‒09
three papers chosen by
Thanos Verousis
University of Bath

  1. Re-regulation of commodity derivative markets: Critical assessment of current reform proposals in the EU and the US By Staritz, Cornelia; Küblböck, Karin
  2. Critical transaction costs and 1-step asymptotic arbitrage in fractional binary markets By Fernando Cordero; Lavinia Perez-Ostafe
  3. Testing Price Pressure, Information, Feedback Trading, and Smoothing Effects for Energy Exchange Traded Funds By Chang, Chia-Lin; Ke, Yu-Pei

  1. By: Staritz, Cornelia; Küblböck, Karin
    Abstract: In the context of recent commodity price hikes, a political consensus has emerged on regulatory measures to reduce excessive speculation in commodity derivative markets. This paper gives an overview of current reform proposals of commodity derivate market regulation at the international (G20), US and EU level and assesses their scope and limitations. For such an assessment, the primary functions of commodity derivative markets for the real economy, i.e. price discovery and price risk hedging for commercial traders have to be taken as a benchmark. The paper concludes that important regulatory initiatives have been under way with a focus on improving transparency, regulating over the counter trade, installing position limits and strengthening regulatory authorities. However, there are important limitations, in particular in the form of broad exemptions (e.g. concerning position limits and commercial traders). Regulations that would more substantially reduce the dominance of financial investors and ensure the dominance of fundamentally based trading strategies have only marginally been addressed, such as restrictions on certain trading strategies (e.g. indexbased investments, technical/algorithmic trading, high frequency trading) and price stabilization mechanisms such as a multitier financial transaction tax. A prerequisite for effective regulation is a pro-active, flexible and dynamic approach that reflects on the risks of failure and adapts regulations if necessary given the changing dynamics and complexities of markets. Further, effective regulation has to take into account the multiple and interrelated roles of financial and large commercial traders being increasingly involved in speculative derivative and physical commodity trading. --
    Date: 2013
  2. By: Fernando Cordero; Lavinia Perez-Ostafe
    Abstract: We study the arbitrage opportunities in the presence of transaction costs in a sequence of binary markets approximating the fractional Black-Scholes model. This approximating sequence was constructed by Sottinen and named fractional binary markets. Since, in the frictionless case, these markets admit arbitrage, we aim to determine the size of the transaction costs needed to eliminate the arbitrage from these models. To gain more insight, we first consider only 1-step trading strategies and we prove that arbitrage opportunities appear when the transaction costs are of order $o(1/\sqrt{N})$. Next, we characterize the asymptotic behavior of the smallest transaction costs $\lambda_c^{(N)}$, called "critical" transaction costs, starting from which the arbitrage disappears. Since the fractional Black-Scholes model is arbitrage-free under arbitrarily small transaction costs, one could expect that $\lambda_c^{(N)}$ converges to zero. However, the true behavior of $\lambda_c^{(N)}$ is opposed to this intuition. More precisely, we show, with the help of a new family of trading strategies, that $\lambda_c^{(N)}$ converges to one. We explain this apparent contradiction and conclude that it is appropriate to see the fractional binary markets as a large financial market and to study its asymptotic arbitrage opportunities. Finally, we construct a $1$-step asymptotic arbitrage in this large market when the transaction costs are of order $o(1/N^H)$, whereas for constant transaction costs, we prove that no such opportunity exists.
    Date: 2014–07
  3. By: Chang, Chia-Lin; Ke, Yu-Pei
    Abstract: This paper examines the relationships between flows and returns for five Exchange Traded Funds (ETF) in the U.S. energy sector. Four alternative hypotheses are tested, including the price pressure hypothesis, information (or price release) hypothesis, feedback trading hypothesis, and smoothing hypothesis. The five ETF are the Energy Select Sector SPDR Fund (XLE), iShares U.S. Energy ETF (IYE), iShares Global Energy ETF (IXC), Vanguard Energy ETF (VDE), and PowerShares Dynamic Energy Exploration & Production Portfolio (PXE). A Vector Autoregressive (VAR) model is used to analyze the relationships between energy flows and returns. The empirical results show that energy returns and subsequent energy ETF flows have a negative relationship, thereby supporting the smoothing hypothesis. Moreover, the smoothing effect exists for XLE and IYE during the global financial crisis. Regardless of whether the whole sample period or the sub-samples before, during and after the global financial crisis are used, no evidence is found in support of the price pressure hypothesis, information hypothesis, or feedback trading hypothesis.
    Keywords: Energy Exchange Traded Funds (ETF), Price pressure hypothesis, Information hypothesis, Feedback trading hypothesis, Smoothing hypothesis.
    JEL: C32 G14 G15
    Date: 2014–07–28

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