nep-mst New Economics Papers
on Market Microstructure
Issue of 2023‒10‒30
two papers chosen by
Thanos Verousis, Vlerick Business School

  1. Sizing Strategies for Algorithmic Trading in Volatile Markets: A Study of Backtesting and Risk Mitigation Analysis By S. M. Masrur Ahmed
  2. Mental Models of the Stock Market By Peter Andre; Philipp Schirmer; Johannes Wohlfart

  1. By: S. M. Masrur Ahmed
    Abstract: Backtest is a way of financial risk evaluation which helps to analyze how our trading algorithm would work in markets with past time frame. The high volatility situation has always been a critical situation which creates challenges for algorithmic traders. The paper investigates different models of sizing in financial trading and backtest to high volatility situations to understand how sizing models can lower the models of VaR during crisis events. Hence it tries to show that how crisis events with high volatility can be controlled using short and long positional size. The paper also investigates stocks with AR, ARIMA, LSTM, GARCH with ETF data.
    Date: 2023–09
  2. By: Peter Andre (SAFE and Goethe University Frankfurt); Philipp Schirmer (University of Bonn); Johannes Wohlfart (University of Copenhagen)
    Abstract: Investors’ return expectations are pivotal in stock markets, but the reasoning behind these expectations remains a black box for economists. This paper sheds light on economic agents’ mental models – their subjective understanding – of the stock market, drawing on surveys with the US general population, US retail investors, US financial professionals, and academic experts. Respondents make return forecasts in scenarios describing stale news about the future earnings streams of companies, and we collect rich data on respondents’ reasoning. We document three main results. First, inference from stale news is rare among academic experts but common among households and financial professionals, who believe that stale good news lead to persistently higher expected returns in the future. Second, while experts refer to the notion of market effi-ciency to explain their forecasts, households and financial professionals reveal a neglect of equilibrium forces. They naively equate higher future earnings with higher future returns, neglecting the offsetting effect of endogenous price adjustments. Third, a se-ries of experimental interventions demonstrate that these naive forecasts do not result from inattention to trading or price responses but reflect a gap in respondents’ mental models – a fundamental unfamiliarity with the concept of equilibrium.
    JEL: D83 D84 G11 G12 G41 G51 G53
    Date: 2023–10

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