nep-mst New Economics Papers
on Market Microstructure
Issue of 2018‒08‒27
eight papers chosen by
Thanos Verousis

  1. The Information Content of the Limit Order Book By Arzandeh, Mehdi; Frank, Julieta
  2. The deeds of speed: an agent-based model of market liquidity and flash episodes By Karvik, Geir-Are; Noss, Joseph; Worlidge, Jack; Beale, Daniel
  3. Activism, Strategic Trading, and Liquidity By Kerry Back; Pierre Collin-Dufresne; Vyacheslav Fos; Tao Li; Alexander Ljungqvist
  4. Corporate Bond Dealers' Inventory Risk and FOMC By Alessio Ruzza; Wojciech Zurowski
  5. Brokers and Order Flow Leakage: Evidence from Fire Sales By Andrea Barbon; Marco Di Maggio; Francesco A. Franzoni; Augustin Landier
  6. Quotes, Trades and the Cost of Capital By Rosu, Ioanid; Sojli, Elvira; Tham, Wing Wah
  7. An analysis of high-frequency cryptocurrencies prices dynamics using permutation-information-theory quantifiers By Aurelio F. Bariviera; Luciano Zunino; Osvaldo A. Rosso
  8. Liquidity resilience in the UK gilt futures market: evidence from the order book By Fullwood, Jonathan; Massacci, Daniele

  1. By: Arzandeh, Mehdi; Frank, Julieta
    Abstract: Over the past decade agricultural commodity futures trading has migrated to the electronic platform from the traditional outcry system. Trades in the electronic platform are conducted through a computerized system where all traders submit their orders with their intended prices and number of contracts. The orders that match the best prevailing price from the opposite side are immediately executed and are called market orders. The orders that are not matched immediately are called limit orders and the system storing these orders is the limit order book (LOB). At any point in time, the LOB contains all the resting orders on the demand and supply sides at different price levels in descending and ascending order, respectively, beyond the best bid and best ask (BBA). Recent finance literature has found evidence that informed traders may submit limit orders instead of market orders as a part of their trading strategies. This means the levels of the LOB beyond the BBA may contain valuable information facilitating the price discovery process of these commodities. We reconstruct the LOB for five major agricultural commodities namely lean hogs, live cattle, corn, wheat, and soybeans as well as the CME Emini S&P 500. Three information share metrics are computed. The results show that the contribution of the levels of the LOB beyond the BBA to price discovery of agricultural commodities is over thirty percent, more than that of E-mini S&P 500. Moreover, the results suggest that the levels of LOB beyond BBA have more information for grains than for meats. Au cours de la dernière décennie, les transactions à terme de marchandises agricoles ont migré du système de criée traditionnel vers la plateforme électronique. Les échanges sur la plateforme électronique sont gérés à travers un système informatisé où tous les négociateurs soumettent leurs commandes avec leurs prix et nombres de contrats voulus. Les commandes qui s'alignent au meilleur prix en vigueur du côté opposé sont immédiatement exécutées et sont appelées ordres de valeur marchande. Les commandes qui ne correspondent pas immédiatement sont appelées commandes limitées et le système qui enregistre ces commandes porte le nom de carnet de commandes limitées (limit order book, LOB). À n'importe quel moment dans le temps, le LOB contient toutes les commandes restantes à différents niveaux de prix en ordre décroissant du côté de l'offre et en ordre croissant du côté de la demande au-delà de la meilleure offre et la meilleure demande (best bid and best ask, BBA). La littérature financière récente a trouvé des preuves que les négociateurs informés peuvent soumettre des commandes limitées au lieu d'ordres de valeur marchande dans le cadre de leurs stratégies commerciales. Ceci signifie que les niveaux du LOB au-delà de la BBA peuvent contenir des informations de grande valeur facilitant le processus de découverte des prix de ces marchandises. Nous avons reconstruit le LOB de cinq marchandises agricoles majeures à savoir le porc, le bétail vivant, le maïs, le blé et le soja, de même que le CME E-mini S&P 500. Trois indicateurs de partage de l'information sont calculés. Les résultats montrent que la contribution des niveaux du LOB au-delà de la BBA à la découverte des prix des marchandises agricoles s'élève à plus de trente pour cent, plus que celle de Emini S&P 500. En outre, les résultats suggèrent que les niveaux du LOB au-delà de la BBA offrent plus d'informations pour les céréales que pour les viandes
    Keywords: Agricultural Finance, Marketing
    Date: 2017
  2. By: Karvik, Geir-Are (Bank of England); Noss, Joseph (Bank of England); Worlidge, Jack (Bank of England); Beale, Daniel (Bank of England)
    Abstract: This paper examines the role of high-frequency traders in flash episodes in electronic financial markets. To do so, we construct an agent-based model of a market for a financial asset in which trading occurs through a central limit order book. The model consists of heterogeneous agents with different trading strategies and frequencies, and is calibrated to high-frequency time series data on the sterling-US dollar exchange rate. Flash episodes occur in the model due to the procyclical behaviour of high-frequency market participants. This is aligned with some empirical evidence as to the drivers of real-world flash crashes. We find that the prevalence of flash episodes increases with the frequency with which high-frequency market participants trade compared to their low-frequency counterparts. This provides tentative theoretical evidence that the recent growth in high-frequency trading across some markets has led to flash episodes. Furthermore, we adapt the model so that large movements in price trigger temporary halts in trading (ie circuit breakers). This is found to reduce the magnitude and frequency of flash episodes.
    Keywords: Agent-based modelling; high-frequency trading; financial stability; market liquidity; flash episodes; principal trading firms (PTFs)
    JEL: C63 G11 G12 G17
    Date: 2018–07–27
  3. By: Kerry Back (Rice University); Pierre Collin-Dufresne (Ecole Polytechnique Fédérale de Lausanne, National Bureau of Economic Research (NBER), and Swiss Finance Institute); Vyacheslav Fos (Boston College); Tao Li (City University of Hong Kong); Alexander Ljungqvist (New York University (NYU), National Bureau of Economic Research (NBER), Centre for Economic Policy Research (CEPR), European Corporate Governance Institute (ECGI), and Research Institute of Industrial Economics (IFN))
    Abstract: We analyze dynamic trading by an activist investor who can expend costly effort to affect firm value. We obtain the equilibrium in closed form for a general activism technology, including both binary and continuous outcomes. Variation in parameters can produce either positive or negative relations between market liquidity and economic efficiency, depending on the activism technology and model parameters. Two results that contrast with the previous literature are that (a) the relation between market liquidity and economic efficiency is independent of the activist's initial stake for a broad set of activism echnologies and (b) an increase in noise trading can reduce market liquidity, because it increases uncertainty about the activist's trades (the activist trades in the opposite direction of noise traders) and thereby increases information asymmetry about the activist's intentions.
    Keywords: Kyle model, insider trading, strategic trading, asymmetric information, liquidity, price impact, market depth, activism, unobservable effort, economic efficiency, continuous time
    JEL: G34 G14
    Date: 2016–11
  4. By: Alessio Ruzza (University of Lugano and Swiss Finance Institute); Wojciech Zurowski (University of Lugano and Swiss Finance Institute)
    Abstract: Macroeconomic announcements increase trading activity, with potential consequences for liquidity. This paper studies the effect of FOMC announcements on the US corporate bond market liquidity. The releases do not seem to create adverse selection. We obtain the probability distribution of monetary policy outcomes from 30 day Fed funds Futures. Despite the low toxicity of the order flow, dealers increase the price for liquidity provision in the presence of monetary policy uncertainty and unexpected Fed rate changes. Trading costs decomposition reveals that inventory risk aversion drives the dealers' behaviour. We conclude that a dealership market falls short around macroeconomic announcements, even when adverse selection may be absent.
    Keywords: corporate bond market, inventory risk, FOMC, Fed funds futures
    JEL: G12 G14
    Date: 2017–05
  5. By: Andrea Barbon (Università della Svizzera italiana and Swiss Finance Institute); Marco Di Maggio (Harvard Business School and National Bureau of Economic Research (NBER)); Francesco A. Franzoni (USI Lugano and Swiss Finance Institute); Augustin Landier (Toulouse School of Economics)
    Abstract: Using trade-level data, we study whether brokers play a role in spreading order flow information. We focus on large portfolio liquidations, which result in temporary drops in stock prices, and identify the brokers that intermediate these trades. We show that these brokers’ best clients tend to predate on the liquidating funds: at the beginning of the fire sale, they sell their holdings in the liquidated stocks, to then cover their positions once asset prices start recovering. The predatory trades generate at least 50 basis points over ten days and cause the liquidation costs for the distressed fund to almost double. These results suggest a role of brokers in fostering predatory behavior and raise a red flag for regulators. Moreover, our findings highlight the trade-off between slow execution and potential information leakage in the decision of optimal trading speed.
    Keywords: Predatory Trading, Back Running, Fire Sales, Brokers
    JEL: G1 G12 G23 G24
    Date: 2017–06
  6. By: Rosu, Ioanid; Sojli, Elvira; Tham, Wing Wah
    Abstract: We study the quoting activity of market makers in relation with trading, liquidity, and expected returns. Empirically, we find larger quote-to-trade (QT) ratios in small, illiquid or neglected firms, yet large QT ratios are associated with low expected returns. The last result is driven by quotes, not by trades. We propose a model of quoting activity consistent with these facts. In equilibrium, market makers monitor the market faster (and thus increase the QT ratio) in neglected, difficult-to-understand stocks. They also monitor faster when their clients are less risk averse, which reduces mispricing and lowers expected returns.
    Keywords: Liquidity; price discovery; volatility; trading volume; monitoring; neglected stocks; risk aversion; inventory; high frequency trading
    JEL: G12 G14
    Date: 2017–07–01
  7. By: Aurelio F. Bariviera; Luciano Zunino; Osvaldo A. Rosso
    Abstract: This paper discusses the dynamics of intraday prices of twelve cryptocurrencies during last months' boom and bust. The importance of this study lies on the extended coverage of the cryptoworld, accounting for more than 90\% of the total daily turnover. By using the complexity-entropy causality plane, we could discriminate three different dynamics in the data set. Whereas most of the cryptocurrencies follow a similar pattern, there are two currencies (ETC and ETH) that exhibit a more persistent stochastic dynamics, and two other currencies (DASH and XEM) whose behavior is closer to a random walk. Consequently, similar financial assets, using blockchain technology, are differentiated by market participants.
    Date: 2018–07
  8. By: Fullwood, Jonathan (Bank of England); Massacci, Daniele (Bank of England)
    Abstract: We analyse liquidity dynamics in the UK long gilt futures market. We use a novel order book dataset to assess liquidity resilience to sources of pressure such as policy operations or episodes of financial distress. Our results provide evidence in favour of resilience. We further show that this resilience does not come at the expense of a negative liquidity trend. These findings mitigate the potential trade-off faced by policy makers such as regulators in maintaining an adequate level of liquidity in the UK long gilt futures market.
    Keywords: Gilt future; liquidity; order book; resilience
    JEL: G10 G14 G18
    Date: 2018–07–27

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