nep-mst New Economics Papers
on Market Microstructure
Issue of 2019‒10‒28
three papers chosen by
Thanos Verousis
University of Essex

  1. Cross-Asset Market Order Flow, Liquidity, and Price Discovery By Robert Garrison; Pankaj Jain; Mark Paddrik
  2. Superkurtosis By Degiannakis, Stavros; Filis, George; Siourounis, Grigorios; Trapani, Lorenzo
  3. Conservation Laws in a Limit Order Book By Jan Rosenzweig

  1. By: Robert Garrison (Office of Financial Research); Pankaj Jain (University of Memphis, Office of Financial Research); Mark Paddrik (Office of Financial Research)
    Abstract: Cross-asset market activity can be a channel through which illiquidity risks originating in one market can propagate to others. This paper examines the complex intra-day linkages between the U.S. equity securities market and the equity derivatives market using high-frequency data on S&P 500 index exchange-traded funds and E-mini futures contracts. The paper finds a positive, but short-lived, relationship between the two markets' order flow activities, which relates to the supply, demand, and withdrawal of liquidity between the two markets. The paper also finds that cross-asset market order flow is a key component of liquidity and price discovery, particularly during periods of market volatility.
    Keywords: cross-market arbitrage, order flow, liquidity, market structure, automated markets
    Date: 2019–10–23
  2. By: Degiannakis, Stavros; Filis, George; Siourounis, Grigorios; Trapani, Lorenzo
    Abstract: Risk metrics users assume that the moments of asset returns exist, irrespectively of the trading frequency, hence the observed values of these moments are used to capture the potential losses from asset trading (e.g. with Value-at-Risk (VaR) or Expected Shortfall (ES) calculations). Despite the fact that the behavior of traditional risk metrics is well-examined for high frequency data (e.g. at daily intervals), very little is known on how these metrics behave under Ultra-High Frequency Trading (UHFT). We fill this void by firstly examining the existence of the daily and intraday returns moments, and subsequently by assessing the impact of their (non)existence in a risk management framework. We find that the third and fourth moments of the distribution of asset returns do not exist. We next use both real and simulated data to show that, when daily trading is implemented, VaR or ES deliver estimates in line with what the theory predicts. We show, however, that when UHFT is considered, assuming finite higher order moments, potential losses are much bigger than what the theory predicts, and they increase exponentially as the trading frequency increases. We argue that two possible explanations affect potential loses; first, the exponential increase in the sample data points at UHFT; second, the fact that the data, which are sampled from a heavy-tailed distribution, tend to have higher sample moments than the theory suggests - we call this phenomenon superkurtosis. Our findings entail that traditional risk metrics are unable to properly judge capital adequacy. Hence, the use of risk management techniques such as VaR or ES, by market participants who engage with UHFT, impose serious threats to the stability of financial markets, given that capital ratios may be severely underestimated.
    Keywords: Ultra high frequency trading, risk management, finite moments, superkurtosis.
    JEL: C12 C54 F30 F31 G10 G15 G17
    Date: 2019–10–16
  3. By: Jan Rosenzweig
    Abstract: We present a class of macroscopic models of the Limit Order Book to simulate the aggregate behaviour of market makers in response to trading flows. The resulting models are solved numerically and asymptotically, and a class of similarity solutions linked to order book formation and recovery is explored. The main result is that order book recovery from aggressive liquidity taking follows a simple $t^{1/3}$ scaling law.
    Date: 2019–10

This nep-mst issue is ©2019 by Thanos Verousis. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.