David Abad, Magdalena Massot, Samarpan Nawn, R. Pascual, José Yagüe
Which components of the overall message traffic are effective leading indicators of impending liquidity shortfalls? Using detailed message-level data that flags the orders of HFTs (high-frequency traders), agency ATs (algorithmic traders), and non-ATs, we show that, after controlling for volume and volatility, only the HFTs’ net buying pressure, computed from the inflow of both aggressive and non-aggressive orders, precedes increases in both immediacy costs and price impacts in the short run. Consistent with market making theories of active risk management, cancellations and revisions of outstanding limit orders relate to preceding efficient price returns and enhance the overall signaling capacity of the HFTs’ order flow. Market-wide indicators of the HFTs’ net buying pressure add extra power in anticipating single-stock liquidity drops.
{"title":"Order-flow-based Leading Indicators of Short-term Liquidity Shortfalls","authors":"David Abad, Magdalena Massot, Samarpan Nawn, R. Pascual, José Yagüe","doi":"10.2139/ssrn.3474294","DOIUrl":"https://doi.org/10.2139/ssrn.3474294","url":null,"abstract":"Which components of the overall message traffic are effective leading indicators of impending liquidity shortfalls? Using detailed message-level data that flags the orders of HFTs (high-frequency traders), agency ATs (algorithmic traders), and non-ATs, we show that, after controlling for volume and volatility, only the HFTs’ net buying pressure, computed from the inflow of both aggressive and non-aggressive orders, precedes increases in both immediacy costs and price impacts in the short run. Consistent with market making theories of active risk management, cancellations and revisions of outstanding limit orders relate to preceding efficient price returns and enhance the overall signaling capacity of the HFTs’ order flow. Market-wide indicators of the HFTs’ net buying pressure add extra power in anticipating single-stock liquidity drops.","PeriodicalId":11757,"journal":{"name":"ERN: Other Microeconomics: General Equilibrium & Disequilibrium Models of Financial Markets (Topic)","volume":"218 1","pages":""},"PeriodicalIF":0.0,"publicationDate":"2021-10-26","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"77436609","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We study a financial market in which agents with interdependent values bid for a risky asset. Some agents are privately informed of their own value for the asset while others seek to infer it from the equilibrium price. Due to adverse selection, uninformed agents are less willing than the informed to provide liquidity, and engage in greater bid shading when prices are more informative. While increased participation by informed agents leads to perfect competition in the limit, the market remains illiquid to some degree even with free entry of uninformed traders. The incentive to produce information is increasing in market size and is maximal in a perfectly competitive economy. Price informativeness, on the other hand, is independent of market size. Curtailing information production by one group can reduce adverse selection, and improve liquidity and welfare for all agents.
{"title":"Information, Market Power and Welfare","authors":"Youcheng Lou, Rohit Rahi","doi":"10.2139/ssrn.3922215","DOIUrl":"https://doi.org/10.2139/ssrn.3922215","url":null,"abstract":"We study a financial market in which agents with interdependent values bid for a risky asset. Some agents are privately informed of their own value for the asset while others seek to infer it from the equilibrium price. Due to adverse selection, uninformed agents are less willing than the informed to provide liquidity, and engage in greater bid shading when prices are more informative. While increased participation by informed agents leads to perfect competition in the limit, the market remains illiquid to some degree even with free entry of uninformed traders. The incentive to produce information is increasing in market size and is maximal in a perfectly competitive economy. Price informativeness, on the other hand, is independent of market size. Curtailing information production by one group can reduce adverse selection, and improve liquidity and welfare for all agents.","PeriodicalId":11757,"journal":{"name":"ERN: Other Microeconomics: General Equilibrium & Disequilibrium Models of Financial Markets (Topic)","volume":"20 1","pages":""},"PeriodicalIF":0.0,"publicationDate":"2021-10-09","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"86422758","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Jules H. van Binsbergen, Jungsuk Han, Hongxun Ruan, Ran Xing
We study a dynamic equilibrium model of mutual fund investing under career concerns that features investment opportunities at different horizons. Equilibrium returns are endogenously determined by competition. Short-term investment strategies can benefit fund managers by accelerating skill revelation, while the downside risk is managed by manager exit. In the steady state, a large number of new and unskilled managers exploit the value of this call option, driving down short-term excess returns. A small number of experienced and skilled managers exploit scalable long-term investment opportunities, adding substantial value. We empirically confirm our theoretical predictions using US mutual fund data.
{"title":"An Equilibrium Model of Career Concerns, Investment Horizons, and Mutual Fund Value Added","authors":"Jules H. van Binsbergen, Jungsuk Han, Hongxun Ruan, Ran Xing","doi":"10.2139/ssrn.3920863","DOIUrl":"https://doi.org/10.2139/ssrn.3920863","url":null,"abstract":"We study a dynamic equilibrium model of mutual fund investing under career concerns that features investment opportunities at different horizons. Equilibrium returns are endogenously determined by competition. Short-term investment strategies can benefit fund managers by accelerating skill revelation, while the downside risk is managed by manager exit. In the steady state, a large number of new and unskilled managers exploit the value of this call option, driving down short-term excess returns. A small number of experienced and skilled managers exploit scalable long-term investment opportunities, adding substantial value. We empirically confirm our theoretical predictions using US mutual fund data.","PeriodicalId":11757,"journal":{"name":"ERN: Other Microeconomics: General Equilibrium & Disequilibrium Models of Financial Markets (Topic)","volume":"12 1","pages":""},"PeriodicalIF":0.0,"publicationDate":"2021-10-09","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"79737286","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper theoretically and empirically shows that, when investors are uncertain about how precise is the signal they receive, their beliefs may further diverge after they receive the same piece of information. We test this prediction using trading volume around quarterly earnings announcements of public U.S. firms. Under signal-precision uncertainty, trading volume increases for intermediate levels of earnings surprise and dampens for extreme levels. Dampening is more pronounced when signal-precision uncertainty is high. We propose a novel measure of earnings-announcement-precision uncertainty and show that, first, S-shaped earnings response coefficient and, second, trading volume's dampening for extreme signals are more pronounced for high levels of earnings-announcement-precision uncertainty. Our findings might lead researchers to reconsider their widespread usage of trading volume as a simple proxy for market liquidity.
{"title":"Financial Information and Diverging Beliefs","authors":"C. Armstrong, M. Heinle, Irina Maxime Luneva","doi":"10.2139/ssrn.3780824","DOIUrl":"https://doi.org/10.2139/ssrn.3780824","url":null,"abstract":"This paper theoretically and empirically shows that, when investors are uncertain about how precise is the signal they receive, their beliefs may further diverge after they receive the same piece of information. We test this prediction using trading volume around quarterly earnings announcements of public U.S. firms. Under signal-precision uncertainty, trading volume increases for intermediate levels of earnings surprise and dampens for extreme levels. Dampening is more pronounced when signal-precision uncertainty is high. We propose a novel measure of earnings-announcement-precision uncertainty and show that, first, S-shaped earnings response coefficient and, second, trading volume's dampening for extreme signals are more pronounced for high levels of earnings-announcement-precision uncertainty. Our findings might lead researchers to reconsider their widespread usage of trading volume as a simple proxy for market liquidity.","PeriodicalId":11757,"journal":{"name":"ERN: Other Microeconomics: General Equilibrium & Disequilibrium Models of Financial Markets (Topic)","volume":"88 1","pages":""},"PeriodicalIF":0.0,"publicationDate":"2021-09-20","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"91463471","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Agents are generally uncertain about multiple, and possibly time-varying, structural parameters that drive consumption and financial payoffs but learn through noisy correlated signals, such as aggregate or macroeconomic news. We find that dynamic learning of multivariate time-varying parameters with correlated signals generates endogenous long-run risks resulting in large and never-decaying equity risk premium. In general, the risk premium is driven by intertemporal co-uncertainty, that is, the dynamic covariance of posterior means, rather than uncertainty (i.e., variance of beliefs) that is highlighted in the literature. Signal correlation structure plays a crucial role in the dynamics of beliefs and asset prices and hence the determination of the equity premium. Apart from its quantitative implications, signal correlation generates non-monotone effects of information quality on the equity premium. We also present empirical evidence of the prevalence of highly correlated signals. Our general learning framework highlights the economic effects of correlated signals on Bayesian learning.
{"title":"Dynamic Multivariate Learning with Generalized Information","authors":"Praveen Kumar, James Yae","doi":"10.2139/ssrn.3904938","DOIUrl":"https://doi.org/10.2139/ssrn.3904938","url":null,"abstract":"Agents are generally uncertain about multiple, and possibly time-varying, structural parameters that drive consumption and financial payoffs but learn through noisy correlated signals, such as aggregate or macroeconomic news. We find that dynamic learning of multivariate time-varying parameters with correlated signals generates endogenous long-run risks resulting in large and never-decaying equity risk premium. In general, the risk premium is driven by intertemporal co-uncertainty, that is, the dynamic covariance of posterior means, rather than uncertainty (i.e., variance of beliefs) that is highlighted in the literature. Signal correlation structure plays a crucial role in the dynamics of beliefs and asset prices and hence the determination of the equity premium. Apart from its quantitative implications, signal correlation generates non-monotone effects of information quality on the equity premium. We also present empirical evidence of the prevalence of highly correlated signals. Our general learning framework highlights the economic effects of correlated signals on Bayesian learning.","PeriodicalId":11757,"journal":{"name":"ERN: Other Microeconomics: General Equilibrium & Disequilibrium Models of Financial Markets (Topic)","volume":"323 1","pages":""},"PeriodicalIF":0.0,"publicationDate":"2021-08-03","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"77987059","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We investigate the efficiency of dynamic random matching and bilateral bargaining markets with adverse selection. We take a detail-free approach to the bargaining game, assuming only that: (a) each agent's actions are optimal given the equilibrium market conditions and the equilibrium strategy of the opposing agents; (b) bargaining reveals information about the quality of the object to the uninformed buyer, who cannot commit to acquire the object at a price that exceeds her expected reservation price conditional on such information. We characterize the equilibrium that maximizes the realized gains from trade among all decentralized equilibria. We show this equilibrium features full information revelation during bargaining. This equilibrium also realizes strictly more gains from trade than any equilibrium of trade under a price system, which we use as a benchmark for trade in centralized markets. However, as trading frictions vanish, the optimal decentralized market allocation converges to the optimal centralized market allocation.
{"title":"Arbitrary Bilateral Bargaining in Decentralized Markets for Lemons","authors":"Bruno Barsanetti, Braz Camargo","doi":"10.2139/ssrn.3893225","DOIUrl":"https://doi.org/10.2139/ssrn.3893225","url":null,"abstract":"We investigate the efficiency of dynamic random matching and bilateral bargaining markets with adverse selection. We take a detail-free approach to the bargaining game, assuming only that: (a) each agent's actions are optimal given the equilibrium market conditions and the equilibrium strategy of the opposing agents; (b) bargaining reveals information about the quality of the object to the uninformed buyer, who cannot commit to acquire the object at a price that exceeds her expected reservation price conditional on such information. We characterize the equilibrium that maximizes the realized gains from trade among all decentralized equilibria. We show this equilibrium features full information revelation during bargaining. This equilibrium also realizes strictly more gains from trade than any equilibrium of trade under a price system, which we use as a benchmark for trade in centralized markets. However, as trading frictions vanish, the optimal decentralized market allocation converges to the optimal centralized market allocation.","PeriodicalId":11757,"journal":{"name":"ERN: Other Microeconomics: General Equilibrium & Disequilibrium Models of Financial Markets (Topic)","volume":"56 1","pages":""},"PeriodicalIF":0.0,"publicationDate":"2021-07-25","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"85590084","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We propose a novel approach to solving and analyzing linear rational expectations models with general information frictions. Our approach is built upon policy function iterations in the frequency domain. We develop the theoretical framework of this approach using rational approximation, analytic continuation, and discrete Fourier transform. We provide the numerical implementation accompanied by a flexible object-oriented toolbox. We demonstrate the efficiency and accuracy of our method by studying four models in macroeconomics and finance that feature asymmetric information sets, endogenous signals, and higher-order expectations.
{"title":"Analytic Policy Function Iteration","authors":"Zhao Han, Fei Tan, Jieran Wu","doi":"10.2139/ssrn.3512320","DOIUrl":"https://doi.org/10.2139/ssrn.3512320","url":null,"abstract":"We propose a novel approach to solving and analyzing linear rational expectations models with general information frictions. Our approach is built upon policy function iterations in the frequency domain. We develop the theoretical framework of this approach using rational approximation, analytic continuation, and discrete Fourier transform. We provide the numerical implementation accompanied by a flexible object-oriented toolbox. We demonstrate the efficiency and accuracy of our method by studying four models in macroeconomics and finance that feature asymmetric information sets, endogenous signals, and higher-order expectations.","PeriodicalId":11757,"journal":{"name":"ERN: Other Microeconomics: General Equilibrium & Disequilibrium Models of Financial Markets (Topic)","volume":"1 1","pages":""},"PeriodicalIF":0.0,"publicationDate":"2021-06-24","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"87939625","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We examine a general equilibrium dynamic economy in which each firm i) hires a manager who can divert cash flows and ii) can fire him after poor performance, generating costs to both parties. The contract is terminated when the manager's continuation value reaches his compensation at another firm net of his termination cost. The unique competitive equilibrium features overcompensation, short-termism, and excessive executive tenure unless moral hazard is minimal. When a firm increases executive pay, it increases the cost to other firms to retain their managers, in turn forcing them to raise and front-load their compensation packages. The equilibrium contract can be implemented with inside equity relinquished upon termination. Inefficiencies decrease with the firm's discount rate and the manager's termination cost and increase with the manager's discount rate, the termination cost to the firm, and the moral hazard proxy. Optimal corporate and income tax schedules and transfer fees can generate the social planner's allocation. When moral hazard is minimal, undercompensation, excessive delay in pay, and excessive firing obtain while subsidies and firing fees restore first best.
{"title":"Equilibrium Executive Compensation","authors":"Gilles Chemla, A. Rivera, Liyan Shi","doi":"10.2139/ssrn.3862731","DOIUrl":"https://doi.org/10.2139/ssrn.3862731","url":null,"abstract":"We examine a general equilibrium dynamic economy in which each firm i) hires a manager who can divert cash flows and ii) can fire him after poor performance, generating costs to both parties. The contract is terminated when the manager's continuation value reaches his compensation at another firm net of his termination cost. The unique competitive equilibrium features overcompensation, short-termism, and excessive executive tenure unless moral hazard is minimal. When a firm increases executive pay, it increases the cost to other firms to retain their managers, in turn forcing them to raise and front-load their compensation packages. The equilibrium contract can be implemented with inside equity relinquished upon termination. Inefficiencies decrease with the firm's discount rate and the manager's termination cost and increase with the manager's discount rate, the termination cost to the firm, and the moral hazard proxy. Optimal corporate and income tax schedules and transfer fees can generate the social planner's allocation. When moral hazard is minimal, undercompensation, excessive delay in pay, and excessive firing obtain while subsidies and firing fees restore first best.","PeriodicalId":11757,"journal":{"name":"ERN: Other Microeconomics: General Equilibrium & Disequilibrium Models of Financial Markets (Topic)","volume":"42 1","pages":""},"PeriodicalIF":0.0,"publicationDate":"2021-06-08","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"89560993","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Impacts of high-frequency trading (HFT) on market quality and various actors have been broadly studied. However, what happens when HFT is not a prominent figure in a market remains relatively unexplored. The paper seeks to answer this question focusing on 30 blue chip stocks in an emerging market, Borsa Istanbul, through Dec 2015 to Mar 2017. Despite a low share in the overall activity, HFT has observable effects: liquidity provision by non-HFT traders significantly reduces with HFT; HFT activity on the sell side induces higher volatility; and HFT generates profits on both positive and negative return days. These findings raise concerns regarding HFT and show potential externalities are not specific to the markets with HFT dominance.
{"title":"High-Frequency Trading and Market Quality: The Case of 'Slightly Exposed' Market","authors":"Cumhur Ekinci, Oguz Ersan","doi":"10.2139/ssrn.3190717","DOIUrl":"https://doi.org/10.2139/ssrn.3190717","url":null,"abstract":"Impacts of high-frequency trading (HFT) on market quality and various actors have been broadly studied. However, what happens when HFT is not a prominent figure in a market remains relatively unexplored. The paper seeks to answer this question focusing on 30 blue chip stocks in an emerging market, Borsa Istanbul, through Dec 2015 to Mar 2017. Despite a low share in the overall activity, HFT has observable effects: liquidity provision by non-HFT traders significantly reduces with HFT; HFT activity on the sell side induces higher volatility; and HFT generates profits on both positive and negative return days. These findings raise concerns regarding HFT and show potential externalities are not specific to the markets with HFT dominance.","PeriodicalId":11757,"journal":{"name":"ERN: Other Microeconomics: General Equilibrium & Disequilibrium Models of Financial Markets (Topic)","volume":"171 1","pages":""},"PeriodicalIF":0.0,"publicationDate":"2021-05-19","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"77411173","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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