nep-mst New Economics Papers
on Market Microstructure
Issue of 2016‒05‒21
six papers chosen by
Thanos Verousis

  1. Optimal market making By Olivier Gu\'eant
  2. Public news flow in intraday component models for trading activity and volatility By Adam Clements; Joanne Fuller; Vasilios Papalexiou
  3. Bootstrapping pre-averaged realized volatility under market microstructure noise By Ulrich Hounyo; Sílvia Gonçalves; Nour Meddahi
  4. Market Efficiency in Brazil: some evidence from high-frequency data By Alexandre de Carvalho; Alberto Sanyuan Suen; Felippe Gallo
  5. Quantum theory of securities price formation in financial markets By Jack Sarkissian
  6. Derivatives Pricing with Market Impact and Limit Order Book By Taiga Saito; Akihiko Takahashi

  1. By: Olivier Gu\'eant
    Abstract: Market makers provide liquidity to other market participants: they propose prices at which they stand ready to buy and sell a wide variety of assets. They face a complex optimization problem with static and dynamic components: they need indeed to propose bid and offer/ask prices in an optimal way for making money out of the difference between these two prices (their bid-ask spread), while mitigating the risk associated with price changes -- because they seldom buy and sell simultaneously, and therefore hold long or short inventories which expose them to market risk. In this paper, (i) we propose a general modeling framework which generalizes (and reconciles) the various modeling approaches proposed in the literature since the publication of the seminal paper "High-frequency trading in a limit order book" by Avellaneda and Stoikov, (ii) we prove new general results on the existence and the characterization of optimal market making strategies, (iii) we obtain new closed-form approximations for the optimal quotes, (iv) we extend the modeling framework to the case of multi-asset market making, and (v) we show how the model can be used in practice in the specific case of the corporate bond market and for two credit indices.
    Date: 2016–05
  2. By: Adam Clements (QUT); Joanne Fuller (QUT); Vasilios Papalexiou
    Abstract: Understanding the determinants of, and forecasting asset return volatility are crucial issues in many financial applications. Many earlier studies have considered the impact of trading activity and news arrivals on volatility. This paper develops a range of intraday component models for volatility and order flow that include the impact of news arrivals. Estimates of the conditional mean of order flow, taking into account news flow are included in models ofvolatility providing a superior in-sample fit. At a 1-minute frequency, it is found that first generating forecasts of order flow which are then included in forecasts of volatility leads to superior day-ahead forecasts of volatility. While including overnight news arrivals directly into models for volatility improves in-sample fit, this approach produces inferior forecasts.
    Keywords: Volatility; Order flow; News; Dynamic conditional score; forecasting
    JEL: C22 G00
    Date: 2015–08–26
  3. By: Ulrich Hounyo; Sílvia Gonçalves; Nour Meddahi
    Abstract: The main contribution of this paper is to propose a bootstrap method for inference on integrated volatility based on the pre-averaging approach, where the pre-averaging is done over all possible overlapping blocks of consecutive observations. The overlapping nature of the pre-averaged returns implies that the leading martingale part in the pre-averaged returns are kn-dependent with kn growing slowly with the sample size n. This motivates the application of a blockwise bootstrap method. We show that the “blocks of blocks” bootstrap method is not valid when volatility is time-varying. The failure of the blocks of blocks bootstrap is due to the heterogeneity of the squared pre-averaged returns when volatility is stochastic. To preserve both the dependence and the heterogeneity of squared pre-averaged returns, we propose a novel procedure that combines the wild bootstrap with the blocks of blocks bootstrap. We provide a proof of the first order asymptotic validity of this method for percentile and percentile-t intervals. Our Monte Carlo simulations show that the wild blocks of blocks bootstrap improves the finite sample properties of the existing first order asymptotic theory. We use empirical work to illustrate its use in practice.
    Keywords: Block bootstrap, high frequency data, market microstructure noise, preaveraging, realized volatility, wild bootstrap,
    Date: 2016–05–09
  4. By: Alexandre de Carvalho; Alberto Sanyuan Suen; Felippe Gallo
    Abstract: In this paper we used intraday data to assess market efficiency in Brazil. We used a database of prices and the number of shares traded of liquid stocks listed in Brazil’s stock exchange, BM&FBOVESPA, and disclosures of material facts legally imposed by the Comissão de Valores Mobiliários (CVM), the Brazilian authority for the regulation of security markets. Our findings indicate material facts reported by firms indeed reveal unexpected information to investors. The speed of price response to new information and the observed magnitudes of cumulative returns indicate market participants can benefit from profit opportunities in the minutes close to the release of material facts. Our findings suggest stock prices take up to fifty minutes to incorporate the new information
    Date: 2016–05
  5. By: Jack Sarkissian
    Abstract: We develop a theory of securities price formation and dynamics based on quantum approach and without presuming any similarities with quantum mechanics. Disorder introduced by trading environment leads to probability distribution of returns that is not a smooth curve, but a speckle-pattern fluctuating in both price coordinate and time. This means that any given return can at times acquire a substantial probability of occurring while remaining low on average in time. Still, due to local character of order interaction during price formation the distribution width grows smoothly, has a minimum value at small time scale and a square root behavior at large time scale. Examples of calibration to market data, both intraday and daily, are provided.
    Date: 2016–04
  6. By: Taiga Saito (Financial Research Center at Financial Services Agency, Government of Tokyo); Akihiko Takahashi (Graduate School of Economics, University of Tokyo)
    Abstract: This paper investigates derivatives pricing under existence of liquidity costs and market impacts for the underlying asset in continuous time. Firstly, we formulate the charge for the liquidity cost and the market impact on the derivatives prices through a stochastic control problem that aims to maximize the mark-to-market value of the portfolio less the quadratic hedging error during the hedging period and the liquidation cost at maturity. Then, we obtain the derivatives price by reduction of this charge from the premium in the Bachelier model. Next, we solve a second order semilinear PDE of parabolic type reduced from the HJB equation for the control problem, which is analytically solved or approximated by an asymptotic expansion around a solution to an explicitly solvable nonlinear PDE. We also present numerical examples of the pricing for a quadratic payoff and a European call payoff in different settlement types, and show comparative static analyses.
    Date: 2016–05

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