nep-mst New Economics Papers
on Market Microstructure
Issue of 2018‒08‒20
eight papers chosen by
Thanos Verousis

  1. Price Discovery in Agricultural Futures Markets: Should We Look Beyond the Best Bid-Ask Spread? By Arzandeh, Mehdi; Frank, Julieta
  2. News-based trading strategies By Stefan Feuerriegel; Helmut Prendinger
  3. Electronic Trading in OTC Markets vs. Centralized Exchange By Ying Liu; Sebastian Vogel; Yuan Zhang
  4. Relationship Trading in OTC Markets By Terrence Hendershott; Dan Li; Dmitry Livdan; Norman Schürhoff
  5. Copy Trading By Jose Apesteguia; Jörg Oechssler; Simon Weidenholzer
  6. Disentangling and quantifying market participant volatility contributions By Marcello Rambaldi; Emmanuel Bacry; Jean-Fran\c{c}ois Muzy
  7. Why Do Large Investors Disclose Their Information? By Ying Liu
  8. Inventory Management, Dealers' Connections, and Prices in OTC Markets By Colliard, Jean-Edouard; Foucault, Thierry; Hoffmann, Peter

  1. By: Arzandeh, Mehdi; Frank, Julieta
    Abstract: Price discovery is defined as the incorporation of information to prices through the actions of traders. Previous studies in financial markets have found evidence that informed traders may submit limit orders instead of market orders. If so, the steps of limit order book (LOB) beyond the best bid and best ask spread (BAS) contain valuable information and contribute to price discovery of the underlying asset. This is the first attempt to examine the informativeness of the LOB beyond the BAS for agricultural commodities. We reconstruct the LOB using market depth data and use three information share approaches to test whether the steps of LOB beyond the BAS contribute to price discovery in agricultural commodity markets. This is done for five major agricultural commodities namely live cattle, lean hogs, corn, wheat, and soybeans as well as the CME E-mini S&P 500. We find that a substantial market depth exists at the steps beyond the best bid and ask prices in the futures markets. The results of the three information share measures show that the steps of the LOB beyond the BAS contribute by over 27% to price discovery of futures contracts. Across agricultural commodities, the steps of the LOB beyond the BAS have more information for grains than meats. Moreover, we find that the steps closer to the top of the book, relative to the steps farther, contain more information. These findings suggest that informed traders in futures electronic markets actively use limit orders with price steps beyond the BAS and especially the steps near the top of the book. The results also show that for E-mini S&P 500, the steps closer to the top of the book contain more information at the beginning and the end of the week whereas steps farther have more information in the middle of the week.
    Keywords: Agricultural Finance, Financial Economics, Marketing
    Date: 2017–06–21
  2. By: Stefan Feuerriegel; Helmut Prendinger
    Abstract: The marvel of markets lies in the fact that dispersed information is instantaneously processed and used to adjust the price of goods, services and assets. Financial markets are particularly efficient when it comes to processing information; such information is typically embedded in textual news that is then interpreted by investors. Quite recently, researchers have started to automatically determine news sentiment in order to explain stock price movements. Interestingly, this so-called news sentiment works fairly well in explaining stock returns. In this paper, we design trading strategies that utilize textual news in order to obtain profits on the basis of novel information entering the market. We thus propose approaches for automated decision-making based on supervised and reinforcement learning. Altogether, we demonstrate how news-based data can be incorporated into an investment system.
    Date: 2018–07
  3. By: Ying Liu (University of Lausanne and Swiss Finance Institute); Sebastian Vogel (Ecole Polytechnique Fédérale de Lausanne); Yuan Zhang (Ecole Polytechnique Fédérale de Lausanne)
    Abstract: We model a two-tiered market structure in which an investor can trade an asset on a trading platform with a set of dealers who in turn have access to an interdealer market. The investor's order is informative about the asset's payoff and dealers who were contacted by the investor use this information in the interdealer market. Increasing the number of contacted dealers lowers markups through competition but increases the dealers' costs of providing the asset through information leakage. We then compare a centralized market in which investors can trade among themselves in a central limit order book to a market in which investors have to use the electronic platform to trade the asset. With imperfect competition among dealers, investor welfare is higher in the centralized market if private values are strongly dispersed or if the mass of investors is large.
    Keywords: OTC markets, RFQ, market design, electronic trading, dealer intermediation
    JEL: D44 D82 G12 G14
    Date: 2017–08
  4. By: Terrence Hendershott (University of California); Dan Li (Federal Reserve Board); Dmitry Livdan (University of California); Norman Schürhoff (University of Lausanne, Swiss Finance Institute, and Centre for Economic Policy Research (CEPR))
    Abstract: We examine the network of trading relations between insurers and dealers in the over-the-counter corporate bond market. Comprehensive regulatory data shows that many insurers use only one dealer while the largest insurers have networks of up to forty dealers. Large insurers receive better prices than small insurers. However, execution costs are a non-monotone function of the network size, increasing once the network size exceeds 20 dealers. To understand these facts we build a model of decentralized trade in which insurers trade off the benefits of repeat business against dealer competition. The model can quantitatively fit the distribution of insurers' network sizes and how prices depend on insurers' size.
    Keywords: Over-the-counter market, corporate bond, trading cost, liquidity, decentralization, financial network
    JEL: G12 G14 G24
    Date: 2017–12
  5. By: Jose Apesteguia; Jörg Oechssler; Simon Weidenholzer
    Abstract: Copy trading allows traders in social networks to receive information on the success of other agents in financial markets and to directly copy their trades. Internet platforms like eToro, ZuluTrade, and Tradeo have attracted millions of users in recent years. The present paper studies the implications of copy trading for the risk taking of investors. Implementing an experimental financial asset market, we show that providing information on the success of others leads to a significant increase in risk taking of subjects. This increase in risk taking is even larger when subjects are provided with the option to directly copy others. We conclude that copy trading reduces ex-ante welfare, and leads to excessive risk taking.
    Keywords: copy trading, financial markets, Social Networks, imitatio, experiment.
    JEL: C91 D81 G12 G20
    Date: 2018–07
  6. By: Marcello Rambaldi; Emmanuel Bacry; Jean-Fran\c{c}ois Muzy
    Abstract: Thanks to the access to labeled orders on the Cac40 index future provided by Euronext, we are able to quantify market participants contributions to the volatility in the diffusive limit. To achieve this result we leverage the branching properties of Hawkes point processes. We find that fast intermediaries (e.g., market maker type agents) have a smaller footprint on the volatility than slower, directional agents. The branching structure of Hawkes processes allows us to examine also the degree of endogeneity of each agent behavior. We find that high-frequency traders are more endogenously driven than other types of agents.
    Date: 2018–07
  7. By: Ying Liu (University of Lausanne and Swiss Finance Institute)
    Abstract: Large investors often advertise private information at private talks or in the media. To analyse the incentives for information disclosure, I develop a two-period Kyle (1985) type model in which an informed short-horizon investor strategically discloses private information to enhance price efficiency. I show that information disclosure is optimal when the scope of private information is large and when the large investor has a high reputation. Short investment horizons induce information disclosure among investors and are beneficial for price efficiency. However, strategic information disclosure reduces trading before disclosure and harms price discovery.
    Keywords: Information Disclosure, Price Discovery, Asymmetric Information, Market Microstructure
    JEL: G12 G14
    Date: 2017–11
  8. By: Colliard, Jean-Edouard; Foucault, Thierry; Hoffmann, Peter
    Abstract: We propose a new model of interdealer trading. Dealers trade together to reduce their inventory holding costs. Core dealers share these costs efficiently and provide liquidity to peripheral dealers, who have heterogeneous access to core dealers. We derive predictions about the effects of peripheral dealers’ connectedness to core dealers and the allocation of aggregate inventories between core and peripheral dealers on the distribution of interdealer prices, the efficiency of interdealer trades, and trading costs for the dealers’ clients. For instance, the dispersion of interdealer prices is higher when fewer peripheral dealers are connected to core dealers or when their aggregate inventory is higher.
    Keywords: OTC markets; Interdealer trading; Inventory management
    JEL: G00
    Date: 2018–07–10

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