nep-mst New Economics Papers
on Market Microstructure
Issue of 2022‒09‒12
three papers chosen by
Thanos Verousis

  1. Informed options strategies before corporate events By Augustin, Patrick; Brenner, Menachem; Grass, Gunnar; Orłowski, Piotr; Subrahmanyam, Marti G.
  2. The impact of derivatives on spot markets: Evidence from the introduction of bitcoin futures contracts By Augustin, Patrick; Rubtsov, Alexey; Shin, Donghwa
  3. Automated Market Making and Loss-Versus-Rebalancing By Jason Milionis; Ciamac C. Moallemi; Tim Roughgarden; Anthony Lee Zhang

  1. By: Augustin, Patrick; Brenner, Menachem; Grass, Gunnar; Orłowski, Piotr; Subrahmanyam, Marti G.
    Abstract: We analyze how informed investors trade in the options market ahead of corporate news when they receive private, but noisy, information about the timing and impact of these announcements on stock prices. We propose a framework that ranks options trading strategies (option type, maturity, and strike price) based on their maximum attainable leverage when price-taking investors face market frictions. We exploit the heterogeneity in announcement characteristics across twelve categories of corporate events to support that event-specific information signals are informative for announcement returns and that they impact the optimal choice of option moneyness and tenor.
    Keywords: corporate announcements,derivatives,event studies,insider trading,market microstructure
    JEL: G12 G13 G14 K42
    Date: 2022
  2. By: Augustin, Patrick; Rubtsov, Alexey; Shin, Donghwa
    Abstract: Cryptocurrencies provide a unique opportunity to identify how derivatives impact spot markets. They are fully fungible, trade across multiple spot exchanges at different prices, and futures contracts were selectively introduced on bitcoin (BTC) exchange rates against the USD in December 2017. Following the futures introduction, we find a significantly greater increase in cross-exchange price synchronicity for BTC-USD relative to other exchange rate pairs, as demonstrated by an increase in price correlations and a reduction in arbitrage opportunities and volatility. We also find support for an increase in price efficiency, market quality, and liquidity. The evidence suggests that futures contracts allowed investors to circumvent trading frictions associated with short sale constraints, arbitrage risk associated with block confirmation time, and market segmentation. Overall, our analysis supports the view that the introduction of BTC-USD futures was beneficial to the bitcoin spot market by making the underlying prices more informative.
    Keywords: bitcoin,blockchain,cryptocurrencies,derivatives,fintech,regulation
    JEL: G12 G13 G14 O33 Y80
    Date: 2022
  3. By: Jason Milionis; Ciamac C. Moallemi; Tim Roughgarden; Anthony Lee Zhang
    Abstract: We consider the market microstructure of automated market making and, specifically, constant function market makers (CFMMs), from the economic perspective of passive liquidity providers (LPs). In a frictionless, continuous-time Black-Scholes setting and in the absence of trading fees, we decompose the return of an LP into a instantaneous market risk component and a non-negative, non-decreasing, and predictable component which we call "loss-versus-rebalancing" (LVR, pronounced "lever"). Market risk can be fully hedged, but once eliminated, LVR remains as a running cost that must be offset by trading fee income in order for liquidity provision to be profitable. We show how LVR can be interpreted in many ways: as the cost of pre-commitment, as the time value for giving up future optionality, as the compensator in a Doob-Meyer decomposition, as an adverse selection cost in the form of the profits of arbitrageurs trading against the pool, and as an information cost because the pool does not have access to accurate market prices. LVR is distinct from the more commonly known metric of "impermanent loss" or "divergence loss"; this latter metric is more fundamentally described as "loss-versus-holding" and is not a true running cost. We express LVR simply and in closed-form: instantaneously, it is the scaled product of the variance of prices and the marginal liquidity available in the pool, i.e., LVR is the floating leg of a generalized variance swap. As such, LVR is easily calibrated to market data and specific CFMM structure. LVR provides tradeable insight in both the ex ante and ex post assessment of CFMM LP investment decisions, and can also inform the design of CFMM protocols.
    Date: 2022–08

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