nep-mst New Economics Papers
on Market Microstructure
Issue of 2023‒10‒23
two papers chosen by
Thanos Verousis, Vlerick Business School

  1. Life after Default: Dealer Intermediation and Recovery in Defaulted Corporate Bonds By Friedrich Baumann; Ali Kakhbod; Dmitry Livdan; Abdolreza Nazemi; Norman Schürhoff
  2. Comparing effects of price limit and circuit breaker in stock exchanges by an agent-based model By Takanobu Mizuta; Isao Yagi

  1. By: Friedrich Baumann (Karlsruhe Institute of Technology); Ali Kakhbod (University of California, Berkeley); Dmitry Livdan (University of California, Berkeley; CEPR); Abdolreza Nazemi (Karlsruhe Institute of Technology); Norman Schürhoff (University of Lausanne, Swiss Finance Institute and CEPR)
    Abstract: We examine the trading and pricing of defaulted U.S. corporate bonds. Defaulted bonds are actively traded since the bonds’ natural holders change from buy-and-hold to specialized vulture investors. We document that intermediation after default shifts to dealers with prior expertise in the defaulted bond. These primary dealers locate higher-valuation counterparties in longer intermediation chains and absorb more order flow in their inventory than other dealers. The switch to trading with primary dealers raises recovery rates by 8%. Our results highlight the importance of dealers’ expertise in intermediating specific corporate bonds which stabilizes market functioning and lowers credit risk ex-ante.
    Keywords: corporate default, corporate bonds, recovery rates, over-the-counter markets, dealer networks
    JEL: G12 G14 G24
    Date: 2023–09
  2. By: Takanobu Mizuta; Isao Yagi
    Abstract: The prevention of rapidly and steeply falling market prices is vital to avoid financial crisis. To this end, some stock exchanges implement a price limit or a circuit breaker, and there has been intensive investigation into which regulation best prevents rapid and large variations in price. In this study, we examine this question using an artificial market model that is an agent-based model for a financial market. Our findings show that the price limit and the circuit breaker basically have the same effect when the parameters, limit price range and limit time range, are the same. However, the price limit is less effective when limit the time range is smaller than the cancel time range. With the price limit, many sell orders are accumulated around the lower limit price, and when the lower limit price is changed before the accumulated sell orders are cancelled, it leads to the accumulation of sell orders of various prices. These accumulated sell orders essentially act as a wall against buy orders, thereby preventing price from rising. Caution should be taken in the sense that these results pertain to a limited situation. Specifically, our finding that the circuit breaker is better than the price limit should be adapted only in cases where the reason for falling prices is erroneous orders and when individual stocks are regulated.
    Date: 2023–09

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