nep-mst New Economics Papers
on Market Microstructure
Issue of 2019‒01‒28
six papers chosen by
Thanos Verousis

  1. Trading Volume, Illiquidity and Commonalities in FX Markets By Angelo Ranaldo; Paolo Santucci de Magistris; ;
  2. Heterogeneous Information Content of Global FX Trading By Angelo Ranaldo; Fabricius Somogyi; ;
  3. Banks’ Trading after the Lehman Crisis – The Role of Unconventional Monetary Policy By Isabel Schnabel; Johannes Tischer
  4. Opacity, Liquidity and Disclosure Policies By André Stenzel; Wolf Wagner
  5. Trading Motives in Asset Markets By Wang, Zijian
  6. A Model of Market Making with Heterogeneous Speculators By Leonardo Bargigli

  1. By: Angelo Ranaldo; Paolo Santucci de Magistris; ;
    Abstract: We provide a unified model for foreign exchange (FX), trading volume, and volatility in a multi-currency environment. Tied by arbitrage conditions, FX rates are determined by common information and trader-specific components generating heterogeneous reservation prices thus inducing trading. Our model outlines new properties including volume-volatility relationships between direct and synthetic FX rates. It also provides a theoretical foundation for commonalities of volume, volatility, and illiquidity across currencies and time, and an intuitive closed-form solution for the price impact measure. Using unique (intraday) data representative for the global FX spot market, the empirical analysis validates our theoretical predictions.
    Keywords: FX Trading Volume, Volatility, Illiquidity, MDH, Commonalities, Co-Jumps
    JEL: C15 F31 G12 G15
    Date: 2018–11
  2. By: Angelo Ranaldo; Fabricius Somogyi; ;
    Abstract: This paper studies the information content of trades in the world's largest over-the-counter market, the foreign exchange (FX) market. The results are derived from a comprehensive order flow dataset distinguishing between different groups of market participants and covering a broad cross-section of currency pairs. Our findings show that both the contemporary and permanent price impact are heterogeneous across agents, time, and currency pairs, supporting the asymmetric information theory. A trading strategy based on the permanent price impact capturing superior information generates high returns even after accounting for risk, transaction costs, and other common risk factors documented in the FX literature.
    Keywords: Carry trade, Currency portfolios, Heterogeneity, Order flow, Price discovery
    JEL: G12 G15 F31
    Date: 2018–09
  3. By: Isabel Schnabel; Johannes Tischer
    Abstract: Based on a unique trade-level dataset, we analyze the proprietary trading reaction of German banks to the Lehman collapse and the subsequent unconventional monetary policy measures in 2008. After the Lehman collapse, we observe that market liquidity tightened. However, there is no evidence of broad-based fire sales in the German banking sector. Instead, we observe a flight to liquidity. The European Central Bank’s unconventional measures had a strong impact on banks’ trading behavior by inducing shifts towards eligible securities and reducing pressure on market liquidity. This suggests that the unconventional measures helped stabilizing the financial system after the Lehman collapse.
    Keywords: Proprietary trading, fire sales, flight to liquidity, Lehman crisis, market liquidity, unconventional monetary policy
    JEL: E44 E50 G01 G11 G21
    Date: 2018–08
  4. By: André Stenzel; Wolf Wagner
    Abstract: We present a model that links the opacity of an asset to its liquidity. While low opacity assets are liquid, intermediate levels of opacity provide incentives for investors to acquire private information, causing adverse selection and illiquidity. High opacity, however, benefits liquidity by reducing the value of a unit of private information to investors. The cross-section of bid-ask spreads of U.S. firms is shown to be consistent with this hump-shape relationship between opacity and illiquidity. Our analysis suggests that uniform disclosure standards may be suboptimal; efficient disclosure can instead be achieved through a two-tier standard system or by subsidizing voluntary disclosure.
    Keywords: disclosure requirements, liquidity, opacity, asymmetric information
    JEL: M40 M48 G14
    Date: 2018–12
  5. By: Wang, Zijian
    Abstract: I study how trading motives in asset markets affect equilibrium outcomes and welfare. I focus on two types of trading motives -- informational and allocational. I show that while a fully separating equilibrium is the unique equilibrium when trading motives are known, multiple equilibria exist when trading motives are unknown. Moreover, forcing traders to reveal their trading motives may harm welfare. I also use this model to study how an asset market may exit a fire sale equilibrium and how government programs may eliminate private information and improve agents' welfare.
    Keywords: Asset markets, private information, competitive search, government intervention
    JEL: D82 D83 G12 G18
    Date: 2019–01–08
  6. By: Leonardo Bargigli
    Abstract: I introduce an optimizing monopolistic market maker in an otherwise standard setting a la Brock and Hommes (1998) (BH98). The market maker manages her inventory of a zero yielding asset, such as foreign currency, and can earn profits from trading, taking advantage of her knowledge of speculators' demand. The resulting dynamic behavior is qualitatively identical to the one described in BH98, showing that the results of the latter are independent from the institutional framework of the market. At the same time I show that the market maker has conflicting effects. She acts as a stabilizer when she allows for market imbalances, while she acts as a destabilizer when she manages aggressively her inventories and when she trades actively, both if she acts as fundamentalist or if she is a strong extrapolator. Indeed the more stable institutional framework is one in which market makers are inventory neutral and don't trade actively but, even in this case, the typical complex behavior of BH98 occurs.
    Keywords: Asset pricing model, heterogeneous beliefs, market architecture, market making, foreign exchange market.
    JEL: G12 D84 D42 C62 F31
    Date: 2019

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