nep-mst New Economics Papers
on Market Microstructure
Issue of 2014‒12‒19
six papers chosen by
Thanos Verousis

  1. Jumps in Option Prices and Their Determinants: Real-time Evidence from the E-mini S&P 500 Option Market By George Kapetanios; Michael Neumann; George Skiadopoulos
  2. Heterogeneous Responses to Market Information and The Impact on Price Volatility and Trading Volume: The Case of Class III Milk Futures By Du, Xiaodong; Dong, Fengxia
  3. Estimation of trading costs: Trade indicator models revisited By Theissen, Erik; Zehnder, Lars Simon
  4. Optimal Mean Reversion Trading with Transaction Cost and Stop-Loss Exit By Tim Leung; Xin Li
  5. Financial disclosure and market transparency with costly information processing By Di Maggio, Marco; Pagano, Marco
  6. Competing for Order Flow in OTC Markets By Benjamin Lester; Guillaume Rocheteau; Pierre-Olivier Weill

  1. By: George Kapetanios (Queen Mary University of London); Michael Neumann (Queen Mary University of London); George Skiadopoulos (Queen Mary University of London University of Piraeus)
    Abstract: We study the real-time characteristics and drivers of jumps in option prices. To this end, we employ high frequency data from the 24-hour E-mini S&P 500 options market. We find that option prices do not jump simultaneously across strikes and maturities and are uncorrelated with jumps in the underlying futures price. 14% to 28% of detected option price jumps occur around scheduled news releases. However, it is illiquidity rather than the news content that drives jumps. Evidence suggests that option traders increase bid-ask spreads to account for trading against investors who are skilled processors of public releases.
    Keywords: Asymmetric information, Co-jumps, Limit order markets, Liquidity, Option Markets, News announcements
    JEL: C58 G10 G12 G13
    Date: 2014–10
  2. By: Du, Xiaodong; Dong, Fengxia
    Abstract: Under the theoretical intraday microstructure framework, we analyze the impact of traders’ heterogeneous responses to market information on daily futures price and trading activity by utilizing the unique features of Class III milk futures contract. The cash settlement and classified pricing scheme distinguish milk futures from other commodities. We construct two variables, days to maturity and price deviates, to capture the distinctive features. While days to maturity indicate the length of time before cash settlement in the maturity month, price deviates reflect traders’ heterogeneous responses to weekly published information on milk prices. A structural price volatility-trading volume model is specified and is estimated using the Bayesian Markov chain Monte Carlo method. The results confirm that (i) the closer to cash settlement, the lower milk futures price volatility, which is opposite to the typical “Samuelson effect” for other commodity futures, and (ii) both price variability and trading volume are increasing functions of traders’ heterogeneous responses to market information and therefore are positively associated. The results can be seen as evidence that the USDA weekly published information has significant impact on price and trading activities in the milk futures market.
    Keywords: Bayesian methods, classified pricing, microstructure model, stochastic volatility, Agricultural Finance, Financial Economics, Risk and Uncertainty, C15, G13, Q18.,
    Date: 2014
  3. By: Theissen, Erik; Zehnder, Lars Simon
    Abstract: It is a stylized fact that trade indicator models (e.g. Madhavan, Richardson, and Roomans (1997) and Huang and Stoll (1997)) underestimate the bid-ask spread. We argue that this negative bias is due to an endogeneity problem which is caused by a negative correlation between the arrival of public information and trade direction. In our sample (the component stocks of the DAX30 index) we find that the the average correlation between these variables is -0.193. We develop modified estimators and show that they yield essentially unbiased spread estimates.
    Keywords: trade indicator model,information asymmetry,spread estimation
    JEL: G14 G12
    Date: 2014
  4. By: Tim Leung; Xin Li
    Abstract: Motivated by the industry practice of pairs trading, we study the optimal timing strategies for trading a mean-reverting price spread. An optimal double stopping problem is formulated to analyze the timing to start and subsequently liquidate the position subject to transaction costs. Modeling the price spread by an Ornstein-Uhlenbeck process, we apply a probabilistic methodology and rigorously derive the optimal price intervals for market entry and exit. As an extension, we incorporate a stop-loss constraint to limit the maximum loss. We show that the entry region is characterized by a bounded price interval that lies strictly above the stop-loss level. As for the exit timing, a higher stop-loss level always implies a lower optimal take-profit level. Both analytical and numerical results are provided to illustrate the dependence of timing strategies on model parameters such as transaction cost and stop-loss level.
    Date: 2014–11
  5. By: Di Maggio, Marco; Pagano, Marco
    Abstract: We study a model where some investors ("hedgers") are bad at information processing, while others ("speculators") have superior information-processing ability and trade purely to exploit it. The disclosure of financial information induces a trade externality: if speculators refrain from trading, hedgers do the same, depressing the asset price. Market transparency reinforces this mechanism, by making speculators' trades more visible to hedgers. As a consequence, issuers will oppose both the disclosure of fundamentals and trading transparency. Issuers may either under- or over-provide information compared to the socially efficient level if speculators have more bargaining power than hedgers, while they never under-provide it otherwise. When hedgers have low financial literacy, forbidding their access to the market may be socially efficient.
    Keywords: disclosure,transparency,financial literacy,limited attention,OTC markets
    JEL: D83 D84 G18 G38 K22 M48
    Date: 2014
  6. By: Benjamin Lester; Guillaume Rocheteau; Pierre-Olivier Weill
    Abstract: We develop a model of a two-sided asset market in which trades are intermediated by dealers and are bilateral. Dealers compete to attract order flow by posting the terms at which they execute trades-- which can include prices, quantities, and execution speed--and investors direct their orders toward dealers that offer the most attractive terms. We characterize the equilibrium in a general setting, and illustrate how the model can account for several important trading patterns in over-the-counter markets which do not emerge from existing models. We then study two special cases which allow us to highlight the differences between these existing models, which assume investors engage in random search for dealers and then use ex post bargaining to determine prices, and our model, which utilizes the concept of competitive search in which dealers post terms of trade. Finally, we calibrate our model, illustrate that it generates reasonable quantitative outcomes, and use it to study how trading frictions affect the per-unit trading costs that investors pay in equilibrium.
    JEL: D53 D83 G1 G12
    Date: 2014–10

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