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on Market Microstructure |
| By: | Sungwoo Kang |
| Abstract: | We demonstrate that the choice of normalization for order flow intensity is fundamental to signal extraction in finance, not merely a technical detail. Through theoretical modeling, Monte Carlo simulation, and empirical validation using Korean market data, we prove that market capitalization normalization acts as a ``matched filter'' for informed trading signals, achieving 1.32--1.97$\times$ higher correlation with future returns compared to traditional trading value normalization. The key insight is that informed traders scale positions by firm value (market capitalization), while noise traders respond to daily liquidity (trading volume), creating heteroskedastic corruption when normalizing by trading volume. By reframing the normalization problem using signal processing theory, we show that dividing order flow by market capitalization preserves the information signal while traditional volume normalization multiplies the signal by inverse turnover -- a highly volatile quantity. Our theoretical predictions are robust across parameter specifications and validated by empirical evidence showing 482\% improvement in explanatory power. These findings have immediate implications for high-frequency trading algorithms, risk factor construction, and information-based trading strategies. |
| Date: | 2025–12 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2512.18648 |
| By: | Marcel Nutz; Alessandro Prosperi |
| Abstract: | We study the high-frequency limit of an $n$-trader optimal execution game in discrete time. Traders face transient price impact of Obizhaeva--Wang type in addition to quadratic instantaneous trading costs $\theta(\Delta X_t)^2$ on each transaction $\Delta X_t$. There is a unique Nash equilibrium in which traders choose liquidation strategies minimizing expected execution costs. In the high-frequency limit where the grid of trading dates converges to the continuous interval $[0, T]$, the discrete equilibrium inventories converge at rate $1/N$ to the continuous-time equilibrium of an Obizhaeva--Wang model with additional quadratic costs $\vartheta_0(\Delta X_0)^2$ and $\vartheta_T(\Delta X_T)^2$ on initial and terminal block trades, where $\vartheta_0=(n-1)/2$ and $\vartheta_T=1/2$. The latter model was introduced by Campbell and Nutz as the limit of continuous-time equilibria with vanishing instantaneous costs. Our results extend and refine previous results of Schied, Strehle, and Zhang for the particular case $n=2$ where $\vartheta_0=\vartheta_T=1/2$. In particular, we show how the coefficients $\vartheta_0=(n-1)/2$ and $\vartheta_T=1/2$ arise endogenously in the high-frequency limit: the initial and terminal block costs of the continuous-time model are identified as the limits of the cumulative discrete instantaneous costs incurred over small neighborhoods of $0$ and $T$, respectively, and these limits are independent of $\theta>0$. By contrast, when $\theta=0$ the discrete-time equilibrium strategies and costs exhibit persistent oscillations and admit no high-frequency limit, mirroring the non-existence of continuous-time equilibria without boundary block costs. Our results show that two different types of trading frictions -- a fine time discretization and small instantaneous costs in continuous time -- have similar regularizing effects and select a canonical model in the limit. |
| Date: | 2025–12 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2512.11765 |
| By: | Fay\c{c}al Drissi; Xuchen Wu; Sebastian Jaimungal |
| Abstract: | We develop an economic model of decentralised exchanges (DEXs) in which risk-averse liquidity providers (LPs) manage risk in a centralised exchange (CEX) based on preferences, information, and trading costs. Rational, risk-averse LPs anticipate the frictions associated with replication and manage risk primarily by reducing the reserves supplied to the DEX. Greater aversion reduces the equilibrium viability of liquidity provision, resulting in thinner markets and lower trading volumes. Greater uninformed demand supports deeper liquidity, whereas higher fundamental price volatility erodes it. Finally, while moderate anticipated price changes can improve LP performance, larger changes require more intensive trading in the CEX, generate higher replication costs, and induce LPs to reduce liquidity supply. |
| Date: | 2025–12 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2512.19838 |
| By: | Milena Wittwer; Jason Allen |
| Abstract: | We explore how traders' equity capitalization influences asset prices in a framework that accounts for market power. In our model, traders with capital constraints engage in transactions in an imperfectly competitive market. We demonstrate that looser capital constraints elevate both asset prices and price impact, the latter diminishing market liquidity. Using Canadian Treasury auction data, we illustrate how to apply our model to quantify these effects. We estimate the shadow costs of capital constraints by leveraging a temporary policy exemption during 2020-2021. We show that while these constraints are only infrequently binding, their relative impact when activated can be sizable. |
| JEL: | D40 D44 G12 G18 G20 L10 |
| Date: | 2026–01 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:34645 |
| By: | Chabakauri, Georgy; Fos, Vyacheslav; Jiang, Wei |
| Abstract: | Privately informed about firm fundamentals, corporate insiders detect activism-motivated trades better than other traders. This paper solves the model of this novel form of insider trading motivated by non-insider information and presents empirical evidence. Corporate insiders preserve their ownership (restraining from selling or buying more) before activist interventions go public to benefit from price appreciation and to defend their private benefits of control. Surveillance technology facilitates response to pre-disclosure activist trading, especially when positive information about firm fundamentals is absent, supporting the mechanism that insiders attribute order flows to activist interest when speculation on fundamentals can be ruled out. |
| Keywords: | insider trading; activism; market surveillance |
| JEL: | F3 G3 |
| Date: | 2025–12–16 |
| URL: | https://d.repec.org/n?u=RePEc:ehl:lserod:127189 |