nep-mst New Economics Papers
on Market Microstructure
Issue of 2023‒01‒23
three papers chosen by
Thanos Verousis

  1. Order routing and market quality: Who benefits from internalisation? By Umut \c{C}etin; Alaina Danilova
  2. Crypto Wash Trading By Lin William Cong; Xi Li; Ke Tang; Yang Yang
  3. Capital regulation, market-making, and liquidity By Haselmann, Rainer; Kick, Thomas; Singla, Shikhar; Vig, Vikrant

  1. By: Umut \c{C}etin; Alaina Danilova
    Abstract: We analyse two models of liquidity provision to determine the retail traders' preference for marketable order routing. Order internalization is captured by a model of market makers competing for the retail order flow in a Bertrand fashion. On the other hand, the price-taking competitive liquidity providers characterize the open exchange model. We show that, when liquidity providers are risk averse, routing of the marketable orders to the wholesalers is preferred by all retail traders: informed, uninformed and noisy. The unwillingness of liquidity providers to bear risk causes the strategic trader (informed or not) to absorb large shocks in their inventories. This results in mean reverting inventories, price reversal, and lower market depth. The equilibria in both models coincide with Kyle (1985) when liquidity providers are risk neutral. We also identify a universal parameter that allows comparison of market liquidity, profit and value of information across different markets.
    Date: 2022–12
  2. By: Lin William Cong; Xi Li; Ke Tang; Yang Yang
    Abstract: We introduce systematic tests exploiting robust statistical and behavioral patterns in trading to detect fake transactions on 29 cryptocurrency exchanges. Regulated exchanges feature patterns consistently observed in financial markets and nature; abnormal first-significant-digit distributions, size rounding, and transaction tail distributions on unregulated exchanges reveal rampant manipulations unlikely driven by strategy or exchange heterogeneity. We quantify the wash trading on each unregulated exchange, which averaged over 70% of the reported volume. We further document how these fabricated volumes (trillions of dollars annually) improve exchange ranking, temporarily distort prices, and relate to exchange characteristics (e.g., age and userbase), market conditions, and regulation.
    JEL: G18 G23 G29
    Date: 2022–12
  3. By: Haselmann, Rainer; Kick, Thomas; Singla, Shikhar; Vig, Vikrant
    Abstract: We employ a proprietary transaction-level dataset in Germany to examine how capital requirements affect the liquidity of corporate bonds. Using the 2011 European Banking Authority capital exercise that mandated certain banks to increase regulatory capital, we find that affected banks reduce their inventory holdings, pre-arrange more trades, and have smaller average trade size. While non-bank affiliated dealers increase their market-making activity, they are unable to bridge this gap - aggregate liquidity declines. Our results are stronger for banks with a higher capital shortfall, for noninvestment grade bonds, and for bonds where the affected banks were the dominant market-maker.
    Keywords: market-making, capital regulation, bond market liquidity
    JEL: G01 G21 G28
    Date: 2022

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