nep-mst New Economics Papers
on Market Microstructure
Issue of 2020‒10‒05
three papers chosen by
Thanos Verousis

  1. What Do Quoted Spreads Tell Us About Machine Trading at Times of Market Stress? Evidence from Treasury and FX Markets during the COVID-19-Related Market Turmoil in March 2020 By Dobrislav Dobrev; Andrew C. Meldrum
  2. Asset Prices and Liquidity with Market Power and Non-Gaussian Payoffs By Sergei Glebkin; Semyon Malamud; Alberto Teguia
  3. Do Mutual Funds and ETFs Affect the Commonality in Liquidity of Corporate Bonds? By Efe Çötelioğlu

  1. By: Dobrislav Dobrev; Andrew C. Meldrum
    Abstract: We highlight four main results from our analysis. First, we find that quoted spreads did not merely rise to much higher than usual levels on average, but were also oscillating over a wider range; while at some points within the day spreads were substantially wider than on a typical day, at other times spreads were as narrow as on a typical day. This result suggests that market participants, likely including both dealers and PTFs, became less willing to replenish the order book fast enough to keep quoted bid-ask spreads consistently tight in these markets, which may have amplified the initial shock to liquidity, particularly for the 30-year bond. Second, using alternative volume-weighted quoted spread measures we put forward in this note, we also find evidence that some market participants employing machine trading strategies were nonetheless able to mitigate the increase in trading costs—by executing trades when bid-ask spreads were relatively tight. Third, we further document that liquidity conditions in Treasury futures markets deteriorated less than those in Treasury cash markets. Fourth, we find that quoted spreads in other liquid futures markets, such as those for major foreign exchange (FX) rates, increased notably more than most of the Treasury futures market (the exception being the 30-year Ultra Treasury bond futures contract). Our findings thus point to the systemic nature of the market strains in March, extending beyond differences in market structure and participation. Our findings also underscore the potential benefits from the use of sophisticated algorithmic execution strategies that can adapt rapidly to changing liquidity conditions.
    Date: 2020–09–25
  2. By: Sergei Glebkin (INSEAD); Semyon Malamud (Ecole Polytechnique Federale de Lausanne; Centre for Economic Policy Research (CEPR); Swiss Finance Institute); Alberto Teguia (Rice University, Jesse H. Jones Graduate School of Business, Students)
    Abstract: We consider an economy populated by CARA investors who trade, accounting for their price impact, multiple risky assets with arbitrary distributed payoffs. We propose a constructive solution method: finding the equilibrium reduces to solving a linear ordinary differential equation. With market power and non-Gaussian payoffs: (i) the equilibrium is nonlinear and the model can speak to key stylized facts regarding asymmetry and nonlinearity of price response to order imbalances, (ii) when risk aversion decreases, there are more liquidity providers and/or there is less uncertainty about future asset payoffs, liquidity can decrease, (iii) cross-section of returns is affected by endogenous illiquidity.
    Keywords: Price Impact, Higher Cumulants, Strategic Trading, Liquidity, CAPM
    JEL: D21 G31 G32 G35 L11
    Date: 2020–09
  3. By: Efe Çötelioğlu (Swiss Finance Institute; USI Lugano)
    Abstract: The paper studies the effect of demand-side sources on the commonality in liquidity of corporate bonds as the growing mutual fund and ETF ownership in the corporate bond market may give rise to correlated trading across bonds. I document that there is a positive and significant relationship between ETF ownership and liquidity commonality of investment-grade corporate bonds. In contrast, and unlike for equities, I find that mutual fund ownership does not increase commonality in liquidity of corporate bonds. I show that three different channels explain the differential impact of ETFs and mutual funds on liquidity commonality: flow-driven trading, different investor clienteles, and ETF arbitrage mechanism.
    Keywords: Corporate Bonds, Liquidity, Commonality, Arbitrage, Exchange-Traded Funds (ETFs), Mutual Funds
    JEL: G12 G14 G20
    Date: 2020–09

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