nep-mst New Economics Papers
on Market Microstructure
Issue of 2022‒07‒25
two papers chosen by
Thanos Verousis

  1. Estimating spot volatility under infinite variation jumps with market microstructure noise By Qiang Liu; Zhi Liu
  2. A structural model of liquidity in over‑the‑counter markets By Coen, Jamie; Coen, Patrick

  1. By: Qiang Liu; Zhi Liu
    Abstract: Jumps and market microstructure noise are stylized features of high-frequency financial data. It is well known that they introduce bias in the estimation of volatility (including integrated and spot volatilities) of assets, and many methods have been proposed to deal with this problem. When the jumps are intensive with infinite variation, the estimation of spot volatility in a noisy setting is not available and is thus in need. To this end, we propose a novel estimator of spot volatility with a hybrid use of the pre-averaging technique and the empirical characteristic function. Under mild assumptions, the consistency and asymptotic normality results of our estimation were established. Furthermore, we showed that our estimator achieves an almost efficient convergence rate with optimal variance. Simulation studies verified our theoretical conclusions. We also applied our proposed estimator to conduct empirical analyses, such as estimating the weekly volatility curve using second-by-second transaction price data.
    Date: 2022–05
  2. By: Coen, Jamie (Bank of England); Coen, Patrick (Toulouse School of Economics)
    Abstract: We study how firm heterogeneity determines liquidity in over‑the‑counter markets. Using a rich data set on trading in the secondary market for sterling corporate bonds, we build and estimate a flexible model of search and trading in which firms have heterogeneous search costs. We show that the 8% most active traders supply as much liquidity as the remaining 92%. Liquidity is thus vulnerable to shocks to these firms: if the 4% most active traders stop trading, liquidity falls by over 60%. Bank capital regulation reduces the willingness of these active traders to hold assets and thus reduces liquidity. However, trader search, holdings and intermediation respond endogenously to reduce the welfare costs of regulation by 30%. These costs are greater in a stress, when these margins of adjustment are constrained. The introduction of trading platforms, which homogenise the ability of traders to trade frequently, improves aggregate welfare but harms the most active traders who currently profit from supplying liquidity.
    Keywords: Liquidity; over‑the‑counter markets; financial intermediation.
    JEL: D83 G12 L51
    Date: 2022–05–13

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