nep-mst New Economics Papers
on Market Microstructure
Issue of 2021‒02‒01
nine papers chosen by
Thanos Verousis

  1. Dynamics of Return and Liquidity (Co)Jumps in Emerging Foreign Exchange Markets By Serdengecti, Suleyman; Sensoy, Ahmet; Nguyen, Duc Khuong
  2. Does Disagreement Facilitate Informed Trading? Evidence from Activist Investors By Cookson, J. Anthony; Fos, Vyacheslav; Niessner, Marina
  3. Censored EM algorithm for Weibull mixtures: application to arrival times of market orders By Markus Kreer; Ayse Kizilersu; Anthony W. Thomas
  4. The Value of Intermediation in the Stock Market By Marco Di Maggio; Mark Egan; Francesco A. Franzoni
  5. Information Leakage in Energy Derivatives around News Announcements By Marc Bohmann; Vinay Patel
  6. Insider trading in the run-up to merger announcements. Before and after the UK's Financial Services Act 2012 By Rebecaa Pham; Marcel Ausloos
  7. A Bayesian perspective on the microstructure of the price formation process By Joffrey Derchu
  8. When does the tail wag the dog? Curvature and market making By Guillermo Angeris; Alex Evans; Tarun Chitra
  9. A Model of Market Making and Price Impact By Angad Singh

  1. By: Serdengecti, Suleyman; Sensoy, Ahmet; Nguyen, Duc Khuong
    Abstract: We investigate the dynamics of return and liquidity (co)jumps for three of the most traded emerging market currencies vis-à-vis US dollar. We find that an increase in the average bid-ask spread significantly reduces the duration between consecutive return jumps, while liquidity and volatility only play a partial role on the duration between consecutive liquidity jumps and return-liquidity cojumps. There is also evidence of vicious return-liquidity spirals in views of the positive contemporaneous impact of liquidity jumps on volatility and return jumps on the bid-ask spread. Moreover, scheduled macroeconomic news and central bank announcements increase the likelihood of both return and liquidity (co)jumps. Finally, jump adjusted high frequency FX trading strategies are shown to have superior performance over the buy-and-hold strategy.
    Keywords: Exchange rates, jumps, cojumps, emerging markets, market microstructure
    JEL: C1 F3 G1
    Date: 2020–04
  2. By: Cookson, J. Anthony; Fos, Vyacheslav; Niessner, Marina
    Abstract: Abstract We study the effect of investor disagreement on informed trading by activist investors using high-frequency disagreement data derived from the investor social network StockTwits. Greater investor disagreement leads to more trading in the subsequent day by privately-informed activists. Disagreement leads to higher prices and improvements in measured liquidity, but these observed valuation and market liquidity differences do not explain the increase in activist trading. Instead, investor disagreement affects activist trading primarily by facilitating trading by non-activist investors. These findings suggest that investor disagreement not only affects trading by uninformed investors, but also facilitates trading by informed market participants who often take actions aimed at changing corporate policies.
    Date: 2021–01–13
  3. By: Markus Kreer; Ayse Kizilersu; Anthony W. Thomas
    Abstract: In a previous analysis the problem of "zero-inflated" time data (caused by high frequency trading in the electronic order book) was handled by left-truncating the inter-arrival times. We demonstrated, using rigorous statistical methods, that the Weibull distribution describes the corresponding stochastic dynamics for all inter-arrival time differences except in the region near zero. However, since the truncated Weibull distribution was not able to describe the huge "zero-inflated" probability mass in the neighbourhood of zero (making up approximately 50\% of the data for limit orders), it became clear that the entire probability distribution is a mixture distribution of which the Weibull distribution is a significant part. Here we use a censored EM algorithm to analyse data for the difference of the arrival times of market orders, which usually have a much lower percentage of zero inflation, for four selected stocks trading on the London Stock Exchange.
    Date: 2020–12
  4. By: Marco Di Maggio (Harvard Business School; National Bureau of Economic Research (NBER)); Mark Egan (Harvard University - Business School (HBS); National Bureau of Economic Research (NBER)); Francesco A. Franzoni (USI Lugano; Swiss Finance Institute; Centre for Economic Policy Research (CEPR))
    Abstract: Brokers play a critical role in intermediating institutional transactions in the stock market. Despite the importance of brokers, we have limited information on what drives investors’ choices among them. We develop and estimate an empirical model of broker choice that allows us to quantitatively examine each investor’s responsiveness to execution costs, access to research, and order flow information. Studying over 300 million institutional trades, we find that investor demand is relatively inelastic with respect to trading commissions and that investors are willing to pay a premium for access to formal (top research analysts) and informal (order-flow information) research. There is also substantial heterogeneity across investors. Relative to other investors, hedge funds tend to be more price insensitive, place less value on sell-side research, and place more value on order-flow information. Using trader-level data, we find that investors are more likely to execute trades through intermediaries who are located physically closer and are less likely to trade with those that have engaged in misconduct in the past. Lastly, we use our empirical model to investigate soft-dollar arrangements and the unbundling of equity research and execution services related to the MiFID II regulations. We find that the bundling of execution and research potentially allows hedge funds and mutual funds to under-report management fees by 10%.
    Keywords: Financial Intermediation, Institutional Investors, Research Analysts, Broker Networks, Equity Trading
    JEL: L11 G14 G23 G24
    Date: 2021–01
  5. By: Marc Bohmann (University of Technology Sydney); Vinay Patel (University of Technology Sydney)
    Abstract: The authors examine the behavior of US crude oil and natural gas futures options implied volatility–based measures as proxies for information leakage around news announcements between 2007 and 2017. In the five days preceding news releases, they find abnormal changes in the levels of futures options implied volatility spreads and skew. In addition, they report a statistically significant relationship between abnormal announcement date returns and abnormal changes in pre-announcement implied volatility spreads/skew. Their findings indicate that at least some investors are informed about the details of future crude oil and natural gas news.
    Keywords: options; derivatives
    Date: 2020–01–01
  6. By: Rebecaa Pham; Marcel Ausloos
    Abstract: After the 2007/2008 financial crisis, the UK government decided that a change in regulation was required to amend the poor control of financial markets. The Financial Services Act 2012 was developed as a result in order to give more control and authority to the regulators of financial markets. Thus, the Financial Conduct Authority (FCA) succeeded the Financial Services Authority (FSA). An area requiring an improvement in regulation was insider trading. Our study examines the effectiveness of the FCA in its duty of regulating insider trading through utilising the event study methodology to assess abnormal returns in the run-up to the first announcement of mergers. Samples of abnormal returns are examined on periods, under regulation either by the FSA or by the FCA. Practically, stock price data on the London Stock Exchange from 2008-2012 and 2015-2019 is investigated. The results from this study determine that abnormal returns are reduced after the implementation of the Financial Services Act 2012; prices are also found to be noisier in the period before the 2012 Act. Insignificant abnormal returns are found in the run-up to the first announcement of mergers in the 2015-2019 period. This concludes that the FCA is efficient in regulating insider trading.
    Date: 2020–12
  7. By: Joffrey Derchu
    Abstract: We develop a theory of Bayesian price formation in electronic markets. We formulate a stylised model in which market participants update their Bayesian prior on an efficient price with a model-based learning process. We show that exponential intensities for aggressive orders arise naturally in this framework. The resulting theory allows us to derive simple analytic formulas for market dynamics and price impact in the case with Brownian efficient price and informed market takers. In particular we show that for small spreads there is an asymptotic market regime. We illustrate our results with numerical experiments.
    Date: 2020–12
  8. By: Guillermo Angeris; Alex Evans; Tarun Chitra
    Abstract: Liquidity and trading activity on constant function market makers (CFMMs) such as Uniswap, Curve, and Balancer has grown significantly in the second half of 2020. Much of the growth of these protocols has been driven by incentivized pools or 'yield farming', which reward participants in crypto assets for providing liquidity to CFMMs. As a result, CFMMs and associated protocols, which were historically very small markets, now constitute the most liquid trading venues for a large number of crypto assets. But what does it mean for a CFMM to be the most liquid market? In this paper, we propose a basic definition of price sensitivity and liquidity. We show that this definition is tightly related to the curvature of a CFMM's trading function and can be used to explain a number of heuristic results. For example, we show that low-curvature markets are good for coins whose market value is approximately fixed and that high-curvature markets are better for liquidity providers when traders have an informational edge. Additionally, the results can also be used to model interacting markets and explain the rise of incentivized liquidity provision, also known as 'yield farming.'
    Date: 2020–12
  9. By: Angad Singh
    Abstract: Traders constantly consider the price impact associated with changing their positions. This paper seeks to understand how price impact emerges from the quoting strategies of market makers. To this end, market making is modeled as a dynamic auction using the mathematical framework of Stochastic Differential Games. In Nash Equilibrium, the market makers' quoting strategies generate a price impact function that is of the same form as the celebrated Almgren-Chriss model. The key insight is that price impact is the mechanism through which market makers earn profits while matching their books. As such, price impact is an essential feature of markets where flow is intermediated by market makers.
    Date: 2021–01

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