nep-mst New Economics Papers
on Market Microstructure
Issue of 2016‒01‒03
four papers chosen by
Thanos Verousis

  1. On Optimal Pricing Model for Multiple Dealers in a Competitive Market By Wai-Ki Ching; Jia-Wen Gu; Qing-Qing Yang; Tak-Kuen Siu
  2. Hedging of covered options with linear market impact and gamma constraint By B Bouchard; G Loeper; Y Zou
  3. On the Information Flow from Credit Derivatives to the Macroeconomy By Paul Mizen; Veronica Veleanu
  4. Nonlinear dependence modeling with bivariate copulas: Statistical arbitrage pairs trading on the S&P 100 By Krauss, Christopher; Stübinger, Johannes

  1. By: Wai-Ki Ching; Jia-Wen Gu; Qing-Qing Yang; Tak-Kuen Siu
    Abstract: In this paper, the optimal pricing strategy in Avellande-Stoikov's for a monopolistic dealer is extended to a general situation where multiple dealers are present in a competitive market. The dealers' trading intensities, their optimal bid and ask prices and therefore their spreads are derived when the dealers are informed the severity of the competition. The effects of various parameters on the bid-ask quotes and profits of the dealers in a competitive market are also discussed. This study gives some insights on the average spread, profit of the dealers in a competitive trading environment.
    Date: 2015–12
  2. By: B Bouchard (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - Université Paris IX - Paris Dauphine - CNRS - Centre National de la Recherche Scientifique); G Loeper (Monash University (AUSTRALIA) - Monash University (AUSTRALIA), FiQuant - Chaire de finance quantitative - Ecole Centrale Paris); Y Zou (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - Université Paris IX - Paris Dauphine - CNRS - Centre National de la Recherche Scientifique)
    Abstract: Within a financial model with linear price impact, we study the problem of hedging a covered European option under gamma constraint. Using stochastic target and partial differential equation smoothing techniques, we prove that the super-replication price is the viscosity solution of a fully non-linear parabolic equation. As a by-product, we show how ε-optimal strategies can be constructed. Finally, a numerical resolution scheme is proposed.
    Keywords: Stochastic target ,Hedging, Price impact
    Date: 2015–12–22
  3. By: Paul Mizen; Veronica Veleanu
    Abstract: We investigate the information flow from credit default swap (CDS) spreads to macroeconomic activity in the United States and twelve European countries. We show that single-name CDS contracts across maturities and sectors provide significant information that anticipates future contractions. The more heavily traded 5-year maturity contracts and the iTraxx European/Markit North American CDS indexes show stronger results, indicating that these forward-looking and highly liquid instruments confer an economically and statistically significant financial signal for future economic activity. Focusing only on the most liquid CDS contracts, we then examine whether better liquidity in the CDS market is accompanied by a higher level of informed trading. A longer sample of US and previously unexplored European country-level data shows information flow intensifies as we approach credit events, and that the number of credit events provides a useful signal in itself of future economic downturns. Finally, we decompose the CDS premium into a liquidity and a residual component (proxying credit and other market risks), and find evidence that liquidity plays a greater role in explaining future macro outcomes over the sample period.
    Keywords: credit default swaps, liquidity, credit risk, economic activity
    Date: 2015
  4. By: Krauss, Christopher; Stübinger, Johannes
    Abstract: We develop a copula-based pairs trading framework and apply it to the S&P 100 index constituents from 1990 to 2014. We propose an integrated approach, using copulas for pairs selection and trading. Essentially, we fit t-copulas to all possible combinations of pairs in a 12 month formation period. Next, we run a 48 month in-sample pseudo-trading to assess the profitability of mispricing signals derived from the conditional marginal distribution functions of the t-copula. Finally, the most suitable pairs based on the pseudo-trading are determined, relying on profitability criteria and dependence measures. The top pairs are transferred to a 12 month trading period, and traded with individualized exit thresholds. In particular, we differentiate between pairs exhibiting mean-reversion and momentum effects and apply idiosyncratic take-profit and stop-loss rules. For the top 5 mean-reversion pairs, we find out-of-sample returns of 7.98 percent per year; the top 5 momentum pairs yield 7.22 percent per year. Return standard deviations are low, leading to annualized Sharpe ratios of 1.52 (top 5 mean-reversion) and 1.33 (top 5 momentum), respectively. Since we implement this strategy on a highly liquid stock universe, our findings pose a severe challenge to the semi-strong form of market efficiency and demonstrate a sophisticated yet profitable alternative to classical pairs trading.
    Keywords: statistical arbitrage,pairs trading,quantitative strategies,copula
    JEL: G11 G12 G14
    Date: 2015

This nep-mst issue is ©2016 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.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.