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on Market Microstructure |
| By: | Peter G. Dunne (Central Bank of Ireland); Harald Hau (University of Geneva, Swiss Finance Institute, Centre for Economic Policy Research (CEPR), and CESifo (Center for Economic Studies and Ifo Institute)); Michael Moore (University of Warwick) |
| Abstract: | We develop a dynamic model of dealer intermediation between a monopolistic customerdealer (B2C) market and a competitive inter-dealer (B2B) market. Dealers face inventory constraints and adverse selection. We characterize the optimal quote setting and inventory management behavior for both markets in closed form and reveal how price setting in one market segment influences quote behavior in the other. The framework features a unique stable equilibrium for bid and ask quotes in both market segments. We show under which conditions dealer intermediation improves welfare over a spot trading venue which clears synchronous customer demand only, and how increased customer sophistication can make market breakdown more likely at high levels of price volatility. Data from the European sovereign bond market is used to illustrate some of the empirical implications. |
| Keywords: | Dealer Intermediation, Spread Determination, Adverse Selection, Market Segmentation |
| JEL: | G24 G14 |
| URL: | http://d.repec.org/n?u=RePEc:chf:rpseri:rp1229&r=mst |
| By: | Jakub Rojcek (University of Zurich and Swiss Finance Institute) |
| Abstract: | Price impact measures the difference between the best quoted price and the realized price as a function of order size. This paper analyzes how price impact depends on the latency that a market maker is subject to. I propose a tractable model which allows incorporating both order size and latency effects as determinants of price impact. The model is solved analytically and is novel in the theoretical microstructure literature. Larger latency increases adverse selection costs to the market maker and reduces his probability of trading with a slow investor. A larger order size decreases the slow trader’s outside option, making him susceptible to accept a worse price for his trade. It is shown that the first-order effect of increased latency and increased order size is to increase price impact. Their joint impact is also positive. When the probability of trading is taken into consideration, the utility of the slow institutional investor decreases with increasing latency. |
| Keywords: | Price Impact, High-Frequency Trading, Trade Size, Latency, Market Quality, Welfare |
| JEL: | G14 G28 C73 |
| URL: | http://d.repec.org/n?u=RePEc:chf:rpseri:rp1656&r=mst |
| By: | Jean-Philippe Bouchaud (Capital Fund Management); Philipp Krueger (University of Geneva and Swiss Finance Institute); Augustin Landier (Toulouse School of Economics); David Thesmar (MIT Sloan) |
| Abstract: | We propose a theory of one of the most economically significant stock market anomalies, i.e. the ``profitability'' anomaly. In our model, investors forecast future profits using a signal and sticky belief dynamics à la Coibion and Gorodnichenko (2012). In this model, past profits forecast future returns (the profitability anomaly). Using analyst forecast data, we measure expectation stickiness at the firm level and find strong support for three additional predictions of the model: (1) analysts are on average more pessimistic for high profit firms, (2) the profitability anomaly is stronger for stocks which are followed by stickier analysts, and (3) it is also stronger for stocks with more persistent profits. |
| Keywords: | Stock market anomalies, Sticky expectations |
| JEL: | G14 G17 |
| URL: | http://d.repec.org/n?u=RePEc:chf:rpseri:rp1660&r=mst |
| By: | Olivier Rousse (GAEL - Laboratoire d'Economie Appliquée de Grenoble - Grenoble INP - Institut polytechnique de Grenoble - Grenoble Institute of Technology - INRA - Institut National de la Recherche Agronomique - CNRS - Centre National de la Recherche Scientifique - UGA - Université Grenoble Alpes); Benoît Sévi (LEMNA - Laboratoire d'économie et de management de Nantes Atlantique - UN - Université de Nantes) |
| Abstract: | The weekly release of the U.S. inventory level by the DOE-EIA is known as the market mover in the U.S. oil futures market and to be a significant piece of information for all world oil markets in which the WTI is a price benchmark. We uncover suspicious trading patterns in the WTI futures markets in days when the inventory level is released that are higher than economists’ forecasts: there are significantly more orders initiated by buyers in the two hours preceding the official release of the inventory level. We also show a clear drop in the average price of -0.25% ahead of the news release. This is consistent with informed trading. We also provide evidence of an asymmetric response of the oil price to the news, and highlight an over-reaction that is partly compensated in the hours following the announcement. |
| Keywords: | Insider Trading, WTI Crude Oil Futures, Intraday Data, Inventory Release |
| Date: | 2016–12–01 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-01410093&r=mst |
| By: | Masaaki Fukasawa; Mitja Stadje |
| Abstract: | We model a nonlinear price curve quoted in a market as the utility indifference curve of a representative liquidity supplier. As the utility function we adopt a g-expectation. In contrast to the standard framework of financial engineering, a trader is no more price taker as any trade has a permanent market impact via an effect to the supplier's inventory. The P&L of a trading strategy is written as a nonlinear stochastic integral. Under this market impact model, we introduce a completeness condition under which any derivative can be perfectly replicated by a dynamic trading strategy. In the special case of a Markovian setting the corresponding pricing and hedging can be done by solving a semi-linear PDE. |
| Date: | 2017–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1702.01385&r=mst |
| By: | Jose E. Figueroa-Lopez; K. Lee |
| Abstract: | High frequency based estimation methods for a semiparametric pure-jump subordinated Brownian motion exposed to a small additive microstructure noise are developed building on the two-scales realized variations approach originally developed by Zhang et. al. (2005) for the estimation of the integrated variance of a continuous Ito process. The proposed estimators are shown to be robust against the noise and, surprisingly, to attain better rates of convergence than their precursors, method of moment estimators, even in the absence of microstructure noise. Our main results give approximate optimal values for the number K of regular sparse subsamples to be used, which is an important tune-up parameter of the method. Finally, a data-driven plug-in procedure is devised to implement the proposed estimators with the optimal K-value. The developed estimators exhibit superior performance as illustrated by Monte Carlo simulations and a real high-frequency data application. |
| Date: | 2017–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1702.01164&r=mst |
| By: | Volodymyr Vovchak (Swiss Finance Institute) |
| Abstract: | This paper examines the relative importance of liquidity level and liquidity risk for the cross-section of stock returns. A portfolio analysis is implemented to make inferences about the pricing ability of liquidity as a characteristic or as a risk. I find that the ratio of absolute returns-to-volume, the Amihud liquidity measure, is able to explain more variance in stock returns than a battery of liquidity risk measures. My results suggest that trading cost and frictions impact financial markets more than the systemic components of liquidity. |
| Keywords: | Liquidity, Liquidity risk, Asset pricing |
| JEL: | G11 G12 |
| URL: | http://d.repec.org/n?u=RePEc:chf:rpseri:rp1244&r=mst |
| By: | Blankespoor, Elizabeth (Stanford University); deHaan, Ed (University of WA); Zhu, Christina (Stanford University) |
| Abstract: | In 2014, the Associated Press (AP) began using algorithms to write media articles about firms' earnings announcements. These "robo-journalism" articles synthesize information from firms' press releases, analyst reports, and stock performance, and are widely disseminated by major news outlets a few hours after the earnings release. The articles are available for thousands of firms on a quarterly basis, many of which previously received little or no media attention. We use AP's staggered implementation of robo-journalism to examine the effects of media synthesis and dissemination, in a setting where the articles are devoid of private information and are largely exogenous to the firm's earnings news and disclosure choices. We find compelling evidence that automated articles increase firms' trading volume and liquidity. We find no evidence that the articles improve or impede the speed of price discovery. Our study provides novel evidence on the impact of pure synthesis and dissemination of public information in capital markets, and initial insights on the implications of automated journalism for market efficiency. |
| Date: | 2016–11 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:stabus:3490&r=mst |
| By: | Kerstin Kehrle (Independent); Tatjana Xenia Puhan (University of Mannheim and Swiss Life Asset Managers) |
| Abstract: | This paper combines the concept of market sidedness with excess option demand (changes in open interest) to solve the empirical challenge of separating directional from uninformed trading motives in widely available, unsigned options data. Our measure of options market sidedness persistently predicts the sign and strength of stock returns. Trading strategies conditional on the measure are highly profitable. For instance, when the measure indicates positive (negative) information, out-of-the-money calls (puts) generate returns of 27% (32%) over roughly four weeks. Risk-adjusted returns of a long-short equity strategy yield more than 2%. An increase in directionally informed demand predicts a decrease in option liquidity and increases in pricing inefficiency. |
| Keywords: | Option Demand, Market Sidedness, Open Interest, Liquidity, Market Microstructure |
| JEL: | D82 G10 G12 G14 |
| URL: | http://d.repec.org/n?u=RePEc:chf:rpseri:rp1243&r=mst |
| By: | Sannikov, Yuliy (Stanford University); Skrzypacz, Andrzej (Stanford University) |
| Abstract: | We build a linear-quadratic model to analyze trading in a market with private information and heterogeneous agents. Agents receive private taste/inventory shocks and trade continuously. Agents differ in their need for trade as well as the cost to hold excessive inventory. In equilibrium, trade is gradual. Trading speed depends on the number and market power of participants, and trade among large market participants is slower than that among small ones. Price has momentum due to the actions of large traders: it drifts down if the sellers have greater market power than buyers, and vice versa. The model can also answer welfare questions, for example about the social costs and benefits of market consolidation. It can also be extended to allow private information about common value. |
| Date: | 2016–12 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:stabus:3487&r=mst |