nep-mst New Economics Papers
on Market Microstructure
Issue of 2019‒06‒17
seven papers chosen by
Thanos Verousis

  1. Information Environments and High Price Impact Trades: Implication for Volatility and Price Efficiency By Dionne, Georges; Zhou, Xiaozhou
  2. Front-Running and Collusion in Forex Trading By Martin D. D. Evans
  3. Do Superstitious Traders Lose Money? By Utpal Bhattacharya; Wei-Yu Kuo; Tse-Chun Lin; Jing Zhao
  4. Optimal auction duration: A price formation viewpoint By Paul Jusselin; Thibaut Mastrolia; Mathieu Rosenbaum
  5. Dependent Microstructure Noise and Integrated Volatility: Estimation from High-Frequency Data By Li, Z. M.; Laeven, R. J. A.; Vellekoop, M. H.
  6. The Social Costs of Side Trading By Attar, Andrea; Mariotti, Thomas; Salanié, François
  7. Optimal Trading for an Informed Seller By Anastasios Dosis

  1. By: Dionne, Georges (HEC Montreal, Canada Research Chair in Risk Management); Zhou, Xiaozhou (Université du Québec à Montréal (UQAM))
    Abstract: Using high-frequency transaction and Limit Order Book (LOB) data, we extend the identification dimensions of High Price Impact Trades (HPITs) by using LOB matchedness. HPITs are trades associated with disproportionately large price changes relative to their proportion of volume. We nd that a higher presence of HPITs leads to a decline in volatility due to more contrarian trades against uninformed traders, but this decline varies with information environments and liquidity levels. Further, we show that more HPITs lead to higher price eciency for stocks with greater public disclosure and higher liquidity. Our empirical results provide evidence that HPITs mainly reect fundamental-based information in a high public information environment, and belief-based information in a low public information environment.
    Keywords: Price eciency; Price discovery; Limit Order Book; Trade size clustering; Stealth trading.
    JEL: C22 C41 C53 G11
    Date: 2019–06–18
  2. By: Martin D. D. Evans (Department of Economics, Georgetown University)
    Abstract: This paper examines the market-wide effects of front-running and information-sharing by dealers in a quantitative microstructure model of Forex trading. Recent investigations by government regulators and court proceedings reveal that there has been widespread sharing of information among Forex dealers working at major banks, as well as the regular front-running of large customer orders. I use the model to study the effects of unilateral front-running, where individual dealers trade ahead of their own customer orders; and collusive front-running where individual dealers trade ahead of another dealer's customer order based on information that was shared among a group of dealers. I find that both forms of front-running create an information externality that significantly affects order flows and Forex prices by slowing down the process through which inter-dealer trading aggregates information from across the market. Font-running reduces dealers' liquidity provision costs by raising the price customers pay to purchase Forex, and lowering the price they receive when selling Forex. These cost reductions are substantial; they lower costs by more than 90 percent. Front-running also affects other market participants that are not directly involved in front-running trades. The information externality makes these participants less willing to speculate on their private information when trading with dealers. This indirect effect of front-running can reduce participants' expected returns by as much as 10 percent. My analysis also shows that collusive front-running has larger effects on order flows than unilateral front-running because information-sharing reduces the risks dealers face when trading ahead of customer orders. However, in other respects, the effects of collusive and unilateral front-running are quite similar. Greater collusion lowers the costs of providing liquidity and it reduces other participants' expected returns, but the effects are small.
    Keywords: Forex Trading, Order Flows, Forex Price Fixes, Microstructure Trading Models
    JEL: F3 F4 G1
    Date: 2019–06–01
  3. By: Utpal Bhattacharya (Institute for Emerging Market Studies, Hong Kong University of Science and Technology); Wei-Yu Kuo (National Chengchi University); Tse-Chun Lin (University of Hong Kong); Jing Zhao (Hong Kong Polytechnic University)
    Abstract: Do superstitious traders lose money? We answer this question in the context of trading in the Taiwan Futures Exchange, where we exploit the Chinese superstition that the number â8â is lucky and the number â4â is unlucky. We find that individual investors, but not institutional investors, submit disproportionately more limit orders at â8â than at â4.â This imbalance, defined as âsuperstition indexâ for each investor, is positively correlated with trading losses. Superstitious investors lose money mainly because of their bad market timing and stale orders. Nevertheless, the reliance on number superstition for limit order submissions does decrease with trading experience.
    Date: 2019–05
  4. By: Paul Jusselin; Thibaut Mastrolia; Mathieu Rosenbaum
    Abstract: We consider an auction market in which market makers fill the order book during a given time period while some other investors send market orders. We define the clearing price of the auction as the price maximizing the exchanged volume at the clearing time according to the supply and demand of each market participants. Then we derive in a semi-explicit form the error made between this clearing price and the fundamental price as a function of the auction duration. We study the impact of the behavior of market takers on this error. To do so we consider the case of naive market takers and that of rational market takers playing a Nash equilibrium to minimize their transaction costs. We compute the optimal duration of the auctions for 77 stocks traded on Euronext and compare the quality of price formation process under this optimal value to the case of a continuous limit order book. Continuous limit order books are found to be usually sub-optimal. However, in term of our metric, they only moderately impair the quality of price formation process. Order of magnitude of optimal auction durations is from 2 to 10 minutes.
    Date: 2019–06
  5. By: Li, Z. M.; Laeven, R. J. A.; Vellekoop, M. H.
    Abstract: In this paper, we develop econometric tools to analyze the integrated volatility (IV) of the efficient price and the dynamic properties of microstructure noise in high-frequency data under general dependent noise. We first develop consistent estimators of the variance and autocovariances of noise using a variant of realized volatility. Next, we employ these estimators to adapt the pre-averaging method and derive consistent estimators of the IV, which converge stably to a mixed Gaussian distribution at the optimal rate n1/4. To improve the finite sample performance, we propose a multi-step approach that corrects the finite sample bias, which turns out to be crucial in applications. Our extensive simulation studies demonstrate the excellent performance of our multi-step estimators. In an empirical study, we analyze the dependence structures of microstructure noise and provide intuitive economic interpretations; we also illustrate the importance of accounting for both the serial dependence in noise and the finite sample bias when estimating IV.
    Keywords: Dependent microstructure noise, realized volatility, bias correction, integrated volatility, mixing sequences, pre-averaging method
    JEL: C13 C14 C58
    Date: 2019–06–14
  6. By: Attar, Andrea; Mariotti, Thomas; Salanié, François
    Abstract: We study resource allocation under private information when the planner cannot prevent bilateral side trading between consumers and firms. Adverse selection and side trading severely restrict feasible trades: each marginal quantity must be fairly priced given the consumer types who purchase it. The resulting social costs are twofold. First, second-best efficiency and robustness to side trading are in general irreconcilable requirements. Second, there actually exists a unique budget-feasible allocation robust to side trading, which deprives the planner from any capacity to redistribute resources between different types of consumers. We discuss the relevance of our results for insurance and financial markets.
    Keywords: Adverse Selection; Side Trading; Second-Best Allocations.
    JEL: D43 D82 D86
    Date: 2019–06
  7. By: Anastasios Dosis (ESSEC Business School - Essec Business School)
    Abstract: A seller with perfect monopoly power trades an indivisible object with a buyer. Both the seller's and the buyer's valuations for the object depend on its quality, which is privately known by the seller. Moreover, the seller has perfect information about the buyer's valuation for each quality. Even though posting a fixed price is ex ante optimal, it might not be interim individually rational and hence not necessarily implementable. The set of interim optimal allocations is charac-terised by solving a parametric linear maximisation program. These allocations might differ from simple price-posting. If the seller offers a menu of contracts, then allocations that are not interim optimal can be supported as equilibrium allocations. However, this sub-optimality result seems not to be robust if there are at least two buyers who can counter-offer menus of contracts after the seller's offer. In that case, an allocation is an equilibrium allocation if and only if it is interim optimal.
    Keywords: Informed seller,Common values,Interim optimal trading
    Date: 2019–03–09

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