nep-mst New Economics Papers
on Market Microstructure
Issue of 2016‒04‒23
six papers chosen by
Thanos Verousis

  1. A heterogeneous agents equilibrium model for the term structure of bond market liquidity By Schuster, Philipp; Trapp, Monika; Uhrig-Homburg, Marliese
  2. Coordinated Noise Trading: Evidence from Pension Fund Reallocations By Zhi Da; Borja Larrain; Clemens Sialm; José Tessada
  3. An agent-based model of dynamics in corporate bond trading By Braun-Munzinger, Karen; Liu, Zijun; Turrell, Arthur
  4. Execution of Limit and Market Orders with Trade Director, Speed Limiter, and Fill Uncertainty By Brian Bulthuis; Julio Concha; Tim Leung; Brian Ward
  5. Reconstruction of Order Flows using Aggregated Data By Ioane Muni Toke
  6. Margin Trading: Hedonic Returns and Real Losses By Daniel Ladley; Guanqing Liu; James Rockey

  1. By: Schuster, Philipp; Trapp, Monika; Uhrig-Homburg, Marliese
    Abstract: We analyze the impact of market frictions on trading volume and liquidity premia of finite maturity assets when investors differ in their trading needs. Our equilibrium model generates a clientele effect (frequently trading investors only hold short-term assets) and predicts i) a hump-shaped relation between trading volume and maturity, ii) lower trading volumes of older compared to younger assets, iii) an increasing liquidity term structure from ask prices, iv) a decreasing or U-shaped liquidity term structure from bid prices, and v) spill-overs of liquidity from short-term to long-term maturities. Empirical tests for U.S. corporate bonds support our theoretical predictions.
    Keywords: bond liquidity,term structure of liquidity premia,heterogeneous agents,aging effect,trading volume,equilibrium
    JEL: G11 G12
    Date: 2016
  2. By: Zhi Da; Borja Larrain; Clemens Sialm; José Tessada
    Abstract: We document a novel channel through which coordinated noise trading exerts externalities on financial markets dominated by institutional investors. We exploit a unique set of events where Chilean pension fund investors followed an influential financial advisory firm that recommended frequent switches between equity and bond funds. The recommendations, which mostly followed short-term trends, generated large and coordinated fund flows. These flows resulted in substantial price pressure and increased volatility in financial markets. Pension funds increased cash holdings as a response. Our findings suggest that giving retirement savers unconstrained reallocation opportunities may exert negative externalities on financial markets.
    JEL: F32 G02 G11 G12 G14 G15 G18 G23 G28 H31 H55
    Date: 2016–04
  3. By: Braun-Munzinger, Karen (Bank of England); Liu, Zijun (Bank of England); Turrell, Arthur (Bank of England)
    Abstract: We construct a heterogeneous agent-based model of the corporate bond market capturing the interaction of market maker behaviour, fund trading strategies, and cash allocation by investors in funds to study feedback effects and the impact of market changes. The model parameters are calibrated against empirical data on US corporate bond trading. Where available, inputs are taken from market data. Others are calibrated through matching statistical features of market returns such as auto-correlations, volatility and fat tails. We use the model to explore the impact of shocks. We find that the sensitivity of the market maker to demand and the degree to which momentum traders are active strongly influence the over and undershooting of yields in response to a shock. This suggests that correlation in funds’ trading strategies can exacerbate extreme price movements and contribute to the procyclicality of financial markets. While the behaviour of investors in funds based on past experience plays a comparatively smaller role in model dynamics, it represents another source of amplification which could be particularly problematic if investors respond to a shock with greater risk aversion. Simple measures to reduce the speed with which investors can redeem investments can reduce the extent of yield dislocation. We also explore the impact of the growth in passive investment, and find that it increases the tail risk of big yield dislocations after shocks, though, on average, volatility may be reduced.
    Keywords: Agent-based model; corporate bond market; trading strategies
    JEL: C63 G11 G12 G17
    Date: 2016–04–18
  4. By: Brian Bulthuis; Julio Concha; Tim Leung; Brian Ward
    Abstract: We study the optimal execution of market and limit orders with permanent and temporary price impacts as well as uncertainty in the filling of limit orders. Our continuous-time model incorporates a trade speed limiter and a trader director to provide better control on the trading rates. We formulate a stochastic control problem to determine the optimal dynamic strategy for trade execution, with a quadratic terminal penalty to ensure complete liquidation. In addition, we identify conditions on the model parameters to ensure optimality of the controls and finiteness of the associated value functions. For comparison, we also solve the schedule-following optimal execution problem that penalizes deviations from an order schedule. Numerical results are provided to illustrate the optimal market and limit orders over time.
    Date: 2016–04
  5. By: Ioane Muni Toke
    Abstract: In this work we investigate tick-by-tick data provided by the TRTH database for several stocks on three different exchanges (Paris - Euronext, London and Frankfurt - Deutsche B\"orse) and on a 5-year span. We use a simple algorithm that helps the synchronization of the trades and quotes data sources, providing enhancements to the basic procedure that, depending on the time period and the exchange, are shown to be significant. We show that the analysis of the performance of this algorithm turns out to be a a forensic tool assessing the quality of the aggregated database: we are able to track through the data some significant technical changes that occurred on the studied exchanges. We also illustrate the fact that the choices made when reconstructing order flows have consequences on the quantitative models that are calibrated afterwards on such data. Our study also provides elements on the trade signature, and we are able to give a more refined look at the standard Lee-Ready procedure, giving new elements on the way optimal lags should be chosen when using this method. The findings are in line with both financial reasoning and the analysis of an illustrative Poisson model of the order flow.
    Date: 2016–04
  6. By: Daniel Ladley; Guanqing Liu; James Rockey
    Abstract: Margin trading is popular with retail investors around the world. This is a puzzle, since, as we show, it has a negative expected return. Our explanation is that whilst lowering mean returns, the collateral requirement imposed by margin calls induces positive skew in the distribution of returns. Investments in assets with symmetric returns now offer limited losses and a small chance of a large gain, like lottery tickets and other gambles. Results from a unique dataset of retail futures traders show that actual losses are substantial. Traders’ behaviour is demonstrated to be best understood as motivated by hedonic returns.
    Keywords: Margin Trading, Hedonic Trading, Gambling, Recreational Investors
    JEL: G02 G11 G13
    Date: 2016–04

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.