nep-mst New Economics Papers
on Market Microstructure
Issue of 2016‒09‒11
four papers chosen by
Thanos Verousis
University of Newcastle

  1. Puzzles in the Tokyo Fixing in the Forex Market: Order Imbalances and Bank Pricing By Takatoshi Ito; Masahiro Yamada
  2. Portfolio Choice with High Frequency Data: CRRA Preferences and the Liquidity Effect By Rui Pedro Brito; Hélder Sebastião; Pedro Godinho
  3. Are Order Anticipation Strategies Harmful? A Theoretical Approach By Elias Strehle
  4. Algorithmic and High-Frequency Trading Strategies: A Literature Review By Alexandru Mandes

  1. By: Takatoshi Ito (School of International and Public Affairs, Columbia University and National Graduate Institute for Policy Studies); Masahiro Yamada (Faculty of Economics, Hitotsubashi University)
    Abstract: “Fixing” in the foreign exchange market, in Tokyo at 10am and in London at 4pm, is a market practice that determines the bid-ask-mid-point exchange rate at a scheduled time of the day in Japan. The fixing exchange rate is then applied to the settlement of foreign exchange transactions between banks and retail customers including broker dealers, institutional investors, insurance companies, exporters and importers, with varying bid-ask spreads. The findings for the Tokyo fixing are summarized as follows. (1) Price spikes are more frequent than the London fixing. (2) The customer orders are biased toward buying the foreign currencies, and this is predictable. (3) Trading volumes and liquidity concentrate on the USD/JPY. (4) Before 2008, the fixing price set by banks was biased upward, and higher than the highest transaction price during the fixing time window; the banks were earning monopolistic profits, but this gap disappeared after 2008. (5) The fixing price is still above the average transaction prices in the fixing window, suggesting that banks make profits, but that can be understood considering the risk of maintaining the fix for the rest of the business day. And (6) calendar effects also matter for the determination of the fixing rate and the price fluctuation around fixing.
    Keywords: Transfers; foreign exchange markets, fixing, Tokyo fixing, WM/Reuters, efficient market, spikes
    JEL: D43 D47 F30 F31 F33 G12 G15
    Date: 2016–09
  2. By: Rui Pedro Brito (GEMF, Faculty of Economics, University of Coimbra); Hélder Sebastião (GEMF, Faculty of Economics, University of Coimbra); Pedro Godinho (GEMF, Faculty of Economics, University of Coimbra)
    Abstract: This paper suggests a new approach for Portfolio Choice. In this framework, the investor, with CRRA preferences, has two objectives: the maximization of the expected utility and the minimization of the portfolio expected illiquidity. The CRRA utility is measured using the portfolio realized volatility, realized skewness and realized kurtosis, while the portfolio illiquidity is measured using the well-known Amihud illiquidity ratio. Therefore, the investor is able to make her choices directly in the expected utility/liquidity (EU/L) bi-dimensional space. We conduct an empirical analysis in a set of fourteen stocks of the CAC 40 stock market index, using high frequency data for the time span from January 1999 to December 2005 (seven years). The robustness of the proposed model is checked according to the out-of-sample performance of different EU/L portfolios relative to the minimum variance and equally weighted portfolios. For different risk aversion levels, the EU/L portfolios are quite competitive and in several cases consistently outperform those benchmarks, in terms of utility, liquidity and certainty equivalent.
    Keywords: Portfolio choice, high frequency data, realized moments, Ahmihud illiquidity ratio, CRRA preferences. JEL Classification: C44, C55, C58, C61, C63, C88, G11.
    Date: 2016–09
  3. By: Elias Strehle
    Abstract: High frequency traders employ order anticipation strategies to benefit from price impact generated by large institutional investors. While there is little doubt that this practice increases execution shortfall for the institutional investor, it is unclear whether it reduces market quality. We study order anticipation strategies in a game model of optimal execution and derive the unique Nash equilibrium in closed form. Our analysis suggests that order anticipation strategies may positively affect market quality by reducing price deviation and short-term volatility.
    Date: 2016–09
  4. By: Alexandru Mandes (University of Giessen)
    Abstract: The advances in computer and communication technologies have created new opportunities for improving, extending the application of or even developing new trading strategies. Transformations have been observed both at the level of investment decisions, as well as at the order execution layer. This review paper describes how traditional market participants, such as market-makers and order anticipators, have been reshaped and how new trading techniques relying on ultra-low-latency competitive advantage, such as electronic “front running”, function. Also, the natural conflict between liquidity-consumers and liquidity-suppliers has been taken to another level, due to the proliferation of algorithmic trading and electronic liquidity provision strategies.
    Keywords: algorithmic trading, high-frequency trading, electronic market making
    JEL: C10 C61 C63 G19
    Date: 2016

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