nep-mst New Economics Papers
on Market Microstructure
Issue of 2019‒08‒12
four papers chosen by
Thanos Verousis

  1. Fast trading and the virtue of entropy: evidence from the foreign exchange market By Corsetti, Giancarlo; Lafarguette, Romain; Mehl, Arnaud
  2. Liquid Speed: On-Demand Fast Trading at Distributed Exchanges By Michael Brolley; Marius Zoican
  3. Optimal make take fees in a multi market maker environment By Bastien Baldacci; Dylan Possama\"i; Mathieu Rosenbaum
  4. Complexity of ECB Communication and Financial Market Trading By Bernd Hayo; Kai Henseler; Marc Steffen Rapp

  1. By: Corsetti, Giancarlo; Lafarguette, Romain; Mehl, Arnaud
    Abstract: Focusing on the foreign exchange reaction to macroeconomic announcements, we show that fast trading is positively and significantly correlated with the entropy of the distribution of quoted prices in reaction to news: a larger share of fast trading increases the degree of diversity of quotes in the order book, for given liquidity, order book depth and size of order flows. Exploiting the WM Reuters’ reform of the fixing methodology in February 2015 as a natural experiment, we provide evidence that fast trading raises entropy, rather than reacting to it. While more entropy in quoted prices means noisier information and arguably complicates price discovery from an individual trader’s perspective, we show that, in the aggregate, more entropy actually brings traded prices closer to the random walk hypothesis, and improves indicators of market efficiency and quality of trade execution. We estimate that a 10 percent increase in entropy reduces the negative impact of macro news by over 60% for effective spreads, against over 40% for realized spreads and price impacts. Our findings suggest that the main mechanism by which fast trading may have desirable effects on market performance specifically hinges on enhanced heterogeneity in trading patterns, best captured by entropy. JEL Classification: F31, G14, G15
    Keywords: asset pricing, high-frequency quoting, macroeconomic news, market efficiency, quality of trade execution, random walk
    Date: 2019–07
  2. By: Michael Brolley; Marius Zoican
    Abstract: Exchanges acquire excess processing capacity to accommodate trading activity surges associated with zero-sum high-frequency trader (HFT) "duels." The idle capacity's opportunity cost is an externality of low-latency trading. We build a model of decentralized exchanges (DEX) with flexible capacity. On DEX, HFTs acquire speed in real-time from peer-to-peer networks. The price of speed surges during activity bursts, as HFTs simultaneously race to market. Relative to centralized exchanges, HFTs acquire more speed on DEX, but for shorter timespans. Low-latency "sprints" speed up price discovery without harming liquidity. Overall, speed rents decrease and fewer resources are locked-in to support zero-sum HFT trades.
    Date: 2019–07
  3. By: Bastien Baldacci; Dylan Possama\"i; Mathieu Rosenbaum
    Abstract: Following the recent literature on make take fees policies, we consider an exchange wishing to set a suitable contract with several market makers in order to improve trading quality on its platform. To do so, we use a principal-agent approach, where the agents (the market makers) optimise their quotes in a Nash equilibrium fashion, providing best response to the contract proposed by the principal (the exchange). This contract aims at attracting liquidity on the platform. This is because the wealth of the exchange depends on the arrival of market orders, which is driven by the spread of market makers. We compute the optimal contract in quasi explicit form and also derive the optimal spread policies for the market makers. Several new phenomena appears in this multi market maker setting. In particular we show that it is not necessarily optimal to have a large number of market makers in the presence of a contracting scheme.
    Date: 2019–07
  4. By: Bernd Hayo (Philipps-Universitaet Marburg); Kai Henseler (Philipps-Universitaet Marburg); Marc Steffen Rapp (Philipps-Universitaet Marburg)
    Abstract: We examine how the verbal complexity of ECB communications affects financial market trading based on high-frequency data from European stock index futures trading. Studying the 34 events between May 2009 and June 2017, during which the ECB Governing Council press conferences covered unconventional monetary policy measures, and using the Flesch-Kincaid Grade Level to measure the verbal complexity of introductory statements to the press conferences, we find that more complex communications are associated with a lower level of contemporaneous trading. Increasing complexity of introductory statements leads to a temporal shift of trading activity towards the subsequent Q&A session, which suggests that Q&A sessions facilitate market participants’ information processing.
    Keywords: ECB, central bank communication, textual analysis, linguistic complexity, readability, financial markets, European stock markets
    JEL: D83 E52 E58 G12 G14
    Date: 2019

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