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on Market Microstructure |
| By: | Baron Law; Frederi Viens |
| Abstract: | We develop from the ground up a new market-making model tailor-made for high-frequency trading under a limit order book (LOB), based on the well-known classification of order types in market microstructure. Our flexible framework allows arbitrary volume, jump, and spread distributions as well as the use of market orders. It also honors the consistency of price movements upon arrivals of different order types (e.g. price never goes down on buy market order) in addition to respecting the price-time priority of LOB. In contrast to the approach of regular control on diffusion as in the classical Avellaneda and Stoikov market-making framework, we exploit the techniques of optimal switching and impulse control on marked point processes, which have proven to be very effective in modeling the order-book features. The Hamilton-Jacobi-Bellman quasi-variational inequality (HJBQVI) associated with the control problem can be solved numerically via the finite-difference method. We illustrate our optimal trading strategy with a full numerical analysis, calibrated to the order-book statistics of a popular ETF. Our simulation shows that the profit of market-making can be seriously overstated under LOBs with inconsistent price movements. |
| Date: | 2019–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1903.07222&r=all |
| By: | Edouard Challe (Sciences Po); Edouard Chrétien |
| Abstract: | Speculators contemplating an attack (e.g., on a currency peg) must guess the beliefs of other speculators, which they can do by looking at the stock market. As shown in earlier work, this information-gathering process may be destabilising by creating multiple equilibria. This paper studies the role played by the microstructure of the asset market in the emergence of multiple equilibria driven by information aggregation. To do so, we study the outcome of a two-stage global game wherein an asset price determined at the trading stage of the game provides an endogenous public signal about the fundamental that affects traders’ decision to attack in the coordination stage of the game. In the trading stage, placing a full demand schedule (i.e., a continuum of limit orders) is costly, but traders may use riskier (and cheaper) market orders, i.e., order to sell or buy a fixed quantity of assets unconditional on the execution price. Price execution risk reduces traders aggressiveness and hence slows down information aggregation, which ultimately makes multiple equilibria in the coordination stage less likely. In this sense, microstructure frictions that lead to greater individual exposure (to price execution risk) may reduce aggregate uncertainty (by pinning down a unique equilibrium outcome). |
| Keywords: | Market microstructure; Information aggregation; Global game |
| JEL: | C72 D82 G14 |
| Date: | 2018–02 |
| URL: | http://d.repec.org/n?u=RePEc:spo:wpmain:info:hdl:2441/5hem762p8r8ujpo0bt0aihhnsl&r=all |
| By: | Zijian Wang (University of Western Ontario) |
| 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: | G12 D82 D83 G18 |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:uwo:uwowop:20191&r=all |
| By: | Xin Guo; Charles-Albert Lehalle; Renyuan Xu |
| Abstract: | The goal of this paper is to establish a benchmark for transaction cost analysis in bond trading for retail investors. Investors can use this benchmark to improve decisions when requesting quotes from dealers on electronic platforms. This benchmark is constructed in two steps. The first step is to identify abnormal trades by approximating the market liquidity using different statistical regression methods: OLS, two-step LASSO and Elastic Net. The second step is to estimate the amplitude and the decay pattern of price impact using non-parametric methods. A key discovery is the price impact asymmetry between customer-buy orders and costumer sell orders: customer buy orders have a larger price impact than customer sell orders. We show that this asymmetry is statistically significant. |
| Date: | 2019–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1903.09140&r=all |
| By: | Leopoldo Catania; Roberto Di Mari; Paolo Santucci de Magistris |
| Abstract: | The tick structure of thef inancial markets entails that price changes observed at very high frequency are discrete. Departing from this empirical evidence we develop a new model to describe the dynamic properties of multivariate time-series of high frequency price changes, including the high probability of observing no variations (price staleness). We assume the existence of two independent latent/hidden Markov processes determining the dynamic properties of the price changes and the excess probability of the occurrence of zeros. We study the probabilistic properties of the model that generates a zero-in ated mixture of Skellam distributions and we develop an EM estimation procedure with closed-form M step. In the empirical application, we study the joint distribution of the price changes of four assets traded on NYSE. Particular focus is dedicated to the precision of the univariate and multivariate density forecasts, to the quality of the predictions of quantities like the volatility and correlations across assets, and to the possibility of disentangling the di erent sources of zero price variation as generated by absence of news, microstructural frictions or by the offsetting positions taken by the traders. |
| Keywords: | Dynamic Mixtures; Skellam Distribution; Zero-in ated series; EM Algorithm; High frequency prices; Volatility |
| URL: | http://d.repec.org/n?u=RePEc:not:notgts:19/05&r=all |
| By: | Eduardo Dávila; Cecilia Parlatore |
| Abstract: | We study the effect of trading costs on information aggregation and acquisition in financial markets. For a given precision of investors' private information, an irrelevance result emerges when investors are ex-ante identical: price informativeness is independent of the level of trading costs. When investors are ex-ante heterogeneous, anything goes, and a change in trading costs can increase or decrease price informativeness, depending on the source of heterogeneity. Our results are valid under quadratic, linear, and fixed costs. Through a reduction in information acquisition, trading costs reduce price informativeness. We discuss how our results inform the policy debate on financial transaction taxes/Tobin taxes. |
| JEL: | D82 D83 G14 |
| Date: | 2019–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:25662&r=all |
| By: | Mark Paddrik (Office of Financial Research); Stathis Tompaidis (University of Texas at Austin) |
| Abstract: | In over-the-counter markets, dealers facilitate trading by becoming market makers. The costs dealers face, including the cost of holding inventory on balance sheet, and the ease, or difficulty, of reducing their positions, determine the degree of liquidity they provide. We provide a stylized model to examine the implications of these costs on dealer behavior and market liquidity. We use the model to guide an empirical study of the single-name credit default swap (CDS) market between 2010-2016. We find that transaction prices between dealers and clients have progressively become more dependent on the inventories of individual dealers rather than on the aggregate inventory across all dealers. We also find that the volume between clients and dealers decreases across all clients, with larger declines for clients that are depository institutions. At the same time, the volume of interdealer trades decreases, dealer inventories decline, and dealers with large inventories are more likely to trade with clients. Our results are consistent with the view that regulatory reforms implemented following the 2007-09 financial crisis increased the cost of holding inventory for dealers, and the cost of interdealer trading. |
| Keywords: | credit default swaps, liquidity, market making, transaction costs |
| Date: | 2019–03–12 |
| URL: | http://d.repec.org/n?u=RePEc:ofr:wpaper:19-01&r=all |
| By: | Martin D. D. Evans (Department of Economics, Georgetown University); Dagfinn Rime (Department of Finance, BI Norwegian Business School, Oslo) |
| Abstract: | This article presents an overview of research on the Microstructure of Foreign Ex-change Markets. We begin by summarizing the institutional features of FX trading and describe how they have evolved since the 1980s. We then explain how these features are represented in microstructure models of FX trading. Next, we describe the links be- tween microstructure and traditional macro exchange-rate models and summarize how these links have been explored in recent empirical research. Finally, we provide a microstructure perspective on two recent areas of interest in exchange-rate economics: the behavior of returns on currency portfolios, and questions of competition and regulation. |
| Keywords: | Exchange-Rate Dynamics, Microstructure, Order Flows, Liquidity, Electronic trading |
| JEL: | F3 F4 G1 |
| Date: | 2019–03–01 |
| URL: | http://d.repec.org/n?u=RePEc:geo:guwopa:gueconwpa~19-19-01&r=all |
| By: | Alasdair Brown (University of East Anglia); James Reade (Department of Economics, University of Reading); Leighton Vaughan Williams (Nottingham Business School) |
| Abstract: | Prediction markets are a popular platform for eliciting incentivised crowd predictions. In this paper, we examine variation in the information contained in prediction market prices by studying Intrade prices on U.S. elections around the release of opinion polls. We find that poll releases stimulate an immediate uptick in trading activity. However, much of this activity involves relatively inexperienced traders and, as a result, price efficiency declines in the immediate aftermath of a poll release. It is not until more experienced traders enter the market in the following ours that price efficiency recovers. More generally, this suggests that information releases do not necessarily improve prediction market forecasts, but may instead attract noise traders who temporarily reduce price efficiency. |
| Keywords: | prediction markets, opinion polls, price efficiency, information efficiency |
| JEL: | C53 G14 D82 D83 |
| Date: | 2018–03–20 |
| URL: | http://d.repec.org/n?u=RePEc:rdg:emxxdp:em-dp2018-02&r=all |