Market efficiency, the timely incorporation of information into prices, remains a central and controversial issue in finance. The short-horizon predictability of returns from past order flows is an inverse indicator of efficiency. We analyze this predictability for NYSE stocks that traded every day from 1993 through 2002. Mid-quote return predictability is diminished when bid-ask spreads are narrower. Such predictability has declined over time with the minimum tick size. Variance ratios of five-minute and daily returns suggest that prices were closer to random walk benchmarks during decimal regimes than during regimes with higher tick sizes (and wider spreads). These findings support the notion that liquidity stimulates arbitrage activity, which, in turn, enhances market efficiency. Further, as the tick size decreased, open-close/close-open return variance ratios increased, while return autocorrelations decreased. This suggests an increased incorporation of private information into prices during more liquid regimes.
{"title":"Liquidity and Market Efficiency","authors":"Tarun Chordia, Richard Roll, A. Subrahmanyam","doi":"10.2139/ssrn.794264","DOIUrl":"https://doi.org/10.2139/ssrn.794264","url":null,"abstract":"Market efficiency, the timely incorporation of information into prices, remains a central and controversial issue in finance. The short-horizon predictability of returns from past order flows is an inverse indicator of efficiency. We analyze this predictability for NYSE stocks that traded every day from 1993 through 2002. Mid-quote return predictability is diminished when bid-ask spreads are narrower. Such predictability has declined over time with the minimum tick size. Variance ratios of five-minute and daily returns suggest that prices were closer to random walk benchmarks during decimal regimes than during regimes with higher tick sizes (and wider spreads). These findings support the notion that liquidity stimulates arbitrage activity, which, in turn, enhances market efficiency. Further, as the tick size decreased, open-close/close-open return variance ratios increased, while return autocorrelations decreased. This suggests an increased incorporation of private information into prices during more liquid regimes.","PeriodicalId":447775,"journal":{"name":"Capital Markets: Market Microstructure","volume":"35 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2007-03-26","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"122427118","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}
In this paper we propose a new approach for the econometric analysis of the dynamics of price discovery using a structural cointegration model for the price changes in arbitrage linked markets. Our methodology characterizes the dynamics of price discovery based on the impulse response functions from an identified structural cointegration model, and we measure the efficiency of a market’s price discovery by the absolute magnitude of cumulative pricing errors in the price discovery process. We apply our methodology to investigate the extent to which the US dollar contributes to the price discovery of the yen/euro exchange rate. Our results show that substantial price discovery of JPY/EUR occurs through the dollar, and that the efficiency of the dollar’s price discovery is positively related to the relative liquidity of the dollar markets versus the cross rate market.
{"title":"The Dynamics of Price Discovery","authors":"Bingcheng Yan, E. Zivot","doi":"10.2139/ssrn.617161","DOIUrl":"https://doi.org/10.2139/ssrn.617161","url":null,"abstract":"In this paper we propose a new approach for the econometric analysis of the dynamics of price discovery using a structural cointegration model for the price changes in arbitrage linked markets. Our methodology characterizes the dynamics of price discovery based on the impulse response functions from an identified structural cointegration model, and we measure the efficiency of a market’s price discovery by the absolute magnitude of cumulative pricing errors in the price discovery process. We apply our methodology to investigate the extent to which the US dollar contributes to the price discovery of the yen/euro exchange rate. Our results show that substantial price discovery of JPY/EUR occurs through the dollar, and that the efficiency of the dollar’s price discovery is positively related to the relative liquidity of the dollar markets versus the cross rate market.","PeriodicalId":447775,"journal":{"name":"Capital Markets: Market Microstructure","volume":"90 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2007-02-26","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"124805688","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 gives a new answer to the challenging question raised by Glosten (1994): "Is the electronic order book inevitable?". While the order book enables traders to compete to supply anonymous liquidity, the specialist system enables one to reap the benefits from repeated interaction. We compare a competitive limit order book and a limit order book with a specialist, like the NYSE. Thanks to non-anonymous interaction, mediated by brokers, uninformed investors can obtain good liquidity from the specialist. This, however, creates an adverse selection problem on the limit order book. Market liquidity and social welfare are improved by the specialist if adverse selection is severe and if brokers have long horizon, so that reputation becomes a matter of concern for them. In contrast, if asymmetric information is limited, spreads are wider and utilitarian welfare is lower when the specialist competes with the limit order book than in a pure limit order book market.
{"title":"A Challenger to the Limit Order Book: The NYSE Specialist","authors":"Sabrina Buti","doi":"10.2139/ssrn.965674","DOIUrl":"https://doi.org/10.2139/ssrn.965674","url":null,"abstract":"This paper gives a new answer to the challenging question raised by Glosten (1994): \"Is the electronic order book inevitable?\". While the order book enables traders to compete to supply anonymous liquidity, the specialist system enables one to reap the benefits from repeated interaction. We compare a competitive limit order book and a limit order book with a specialist, like the NYSE. Thanks to non-anonymous interaction, mediated by brokers, uninformed investors can obtain good liquidity from the specialist. This, however, creates an adverse selection problem on the limit order book. Market liquidity and social welfare are improved by the specialist if adverse selection is severe and if brokers have long horizon, so that reputation becomes a matter of concern for them. In contrast, if asymmetric information is limited, spreads are wider and utilitarian welfare is lower when the specialist competes with the limit order book than in a pure limit order book market.","PeriodicalId":447775,"journal":{"name":"Capital Markets: Market Microstructure","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2007-02-26","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"125425172","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 puts the PIN variable (Probability of INformation-based trading) to test. We find that for a large set of stocks, the PIN variable is lower (albeit insignificantly) in the periods before earnings announcements dates than in the periods after earnings announcements dates. This is inconsistent with the idea of PIN capturing the probability of informed trading.
{"title":"Testing the Pin Variable","authors":"Evangelos Benos, Marek Jochec","doi":"10.2139/ssrn.933211","DOIUrl":"https://doi.org/10.2139/ssrn.933211","url":null,"abstract":"This paper puts the PIN variable (Probability of INformation-based trading) to test. We find that for a large set of stocks, the PIN variable is lower (albeit insignificantly) in the periods before earnings announcements dates than in the periods after earnings announcements dates. This is inconsistent with the idea of PIN capturing the probability of informed trading.","PeriodicalId":447775,"journal":{"name":"Capital Markets: Market Microstructure","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2007-02-17","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"129011013","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 study investigates the impact of decimalization (penny pricing) on the arbitrage relationship between index exchange-traded funds (ETFs) and E-mini index futures. Our empirical results reveal that subsequent to penny pricing, there is a significant fall in the mean ex-ante arbitrage profit, especially in the cases with higher transaction costs. Using OLS and quantile regressions to control for the influences of changes in market characteristics, we find that the overall pricing efficiency has deteriorated in the post-decimalization period. From the quantile regression analyses, it is found that the pricing efficiency is improved only when an extreme large mispricing signal is observed, implying that due to increased execution risk after decimalization, arbitragers will only execute trades when the expected profit is large enough. These results are consistent with the hypothesis that, due to the lowered market depth and increased execution risks, the introduction of decimalization has in general resulted in weakening the ability and willingness of arbitrageurs to initiate arbitrage trades, which subsequently leads to a reduction in the general efficiency of the cash/futures pricing system.
{"title":"Decimalization and the ETFs and Futures Pricing Efficiency","authors":"Wei-peng Chen, Robin K. Chou, Huimin Chung","doi":"10.2139/ssrn.968349","DOIUrl":"https://doi.org/10.2139/ssrn.968349","url":null,"abstract":"This study investigates the impact of decimalization (penny pricing) on the arbitrage relationship between index exchange-traded funds (ETFs) and E-mini index futures. Our empirical results reveal that subsequent to penny pricing, there is a significant fall in the mean ex-ante arbitrage profit, especially in the cases with higher transaction costs. Using OLS and quantile regressions to control for the influences of changes in market characteristics, we find that the overall pricing efficiency has deteriorated in the post-decimalization period. From the quantile regression analyses, it is found that the pricing efficiency is improved only when an extreme large mispricing signal is observed, implying that due to increased execution risk after decimalization, arbitragers will only execute trades when the expected profit is large enough. These results are consistent with the hypothesis that, due to the lowered market depth and increased execution risks, the introduction of decimalization has in general resulted in weakening the ability and willingness of arbitrageurs to initiate arbitrage trades, which subsequently leads to a reduction in the general efficiency of the cash/futures pricing system.","PeriodicalId":447775,"journal":{"name":"Capital Markets: Market Microstructure","volume":"51 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2007-02-16","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"131811219","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}
Despite many innovations and restructuring in the last years, the securities clearing and settlement industry in Europe is still said to be highly inefficient for cross-border transactions. This paper provides a fact based overview of the market, regulation, and recent developments that aim to improve the efficiency of clearing and settlement in Europe. The European code of conduct for clearing and settlement and TARGET2-Securities are identified as primary concerns in this industry. The code of conduct for clearing and settlement, initiated by the European Commission, intends to improve price transparency, interoperability, and service unbundling. The phased course of action of the code of conduct is presented. An analysis of the current implementation status of the code of conduct shows potentials for improvements. TARGET2-Securities, as technical platform for settlement of securities in Europe, provided by Eurosystem, could have a significant impact on the settlement of securities in Europe. The importance of the participation of all central securities depositories for the success of the platform is shown by a simulation. The different approaches for improving efficiency in cross-border clearing and settlement are compared with each other. TARGET2-Securities could create a monopolistic infrastructure for settlement which stands in contrast to the code of conduct.
{"title":"Trends in European Clearing and Settlement Industry - The European Code of Conduct and Target2-Securities","authors":"Torsten Schaper","doi":"10.2139/ssrn.965407","DOIUrl":"https://doi.org/10.2139/ssrn.965407","url":null,"abstract":"Despite many innovations and restructuring in the last years, the securities clearing and settlement industry in Europe is still said to be highly inefficient for cross-border transactions. This paper provides a fact based overview of the market, regulation, and recent developments that aim to improve the efficiency of clearing and settlement in Europe. The European code of conduct for clearing and settlement and TARGET2-Securities are identified as primary concerns in this industry. The code of conduct for clearing and settlement, initiated by the European Commission, intends to improve price transparency, interoperability, and service unbundling. The phased course of action of the code of conduct is presented. An analysis of the current implementation status of the code of conduct shows potentials for improvements. TARGET2-Securities, as technical platform for settlement of securities in Europe, provided by Eurosystem, could have a significant impact on the settlement of securities in Europe. The importance of the participation of all central securities depositories for the success of the platform is shown by a simulation. The different approaches for improving efficiency in cross-border clearing and settlement are compared with each other. TARGET2-Securities could create a monopolistic infrastructure for settlement which stands in contrast to the code of conduct.","PeriodicalId":447775,"journal":{"name":"Capital Markets: Market Microstructure","volume":"5 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2007-02-15","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"126700984","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 the microstructure effects of the QQQ ETF listing change from AMEX to NASDAQ. We find that even though the stock traded on both venues before and after the listing change, NASDAQ reaped a substantial increase in order flow for QQQ at the expense of the AMEX. The change results in a decline in trading costs, consolidation of order flow, and a less fragmented market for QQQ. We hypothesize that the avoidance of the explicit and implicit costs imposed by the Intermarket Trading System for NASDAQ traders was partly responsible for the improvement in QQQ market quality.
{"title":"Cubes to Quads: The Move of Qqq from Amex to Nasdaq","authors":"Kevin D. Broom, R. Van Ness, Richard S. Warr","doi":"10.2139/ssrn.962451","DOIUrl":"https://doi.org/10.2139/ssrn.962451","url":null,"abstract":"We examine the microstructure effects of the QQQ ETF listing change from AMEX to NASDAQ. We find that even though the stock traded on both venues before and after the listing change, NASDAQ reaped a substantial increase in order flow for QQQ at the expense of the AMEX. The change results in a decline in trading costs, consolidation of order flow, and a less fragmented market for QQQ. We hypothesize that the avoidance of the explicit and implicit costs imposed by the Intermarket Trading System for NASDAQ traders was partly responsible for the improvement in QQQ market quality.","PeriodicalId":447775,"journal":{"name":"Capital Markets: Market Microstructure","volume":"19 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2007-02-09","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"132737530","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 the effects of the introduction of a call auction in the closing stages of the trading day in Borsa Italiana's (BIt) equity markets. We show that the Closing Call Auction (CCA) drastically reduces spread and volatility just before the close of trading, while having a negligible effect on the rest of the day. We attribute this change in market quality to agents' reactions to the new trading opportunity offered by the CCA. We show that the introduction of a CCA significantly reduces the cost of immediacy at the end of continuous trading, and also reduces volatility. This effect is highly concentrated in the last few minutes of continuous trading, without any discernible impact on the rest of the day. To test the robustness of our findings, we compare this outcome with that of the introduction of the CCA on Euronext Paris and find similar results. The differences can be explained in the way the two exchanges calculate the Reference Price. We also document changes in the trading aggressiveness of various types of market participants around the close.
{"title":"The Impact of a Closing Call Auction on Market Quality and Trading Strategies","authors":"Eugene Kandel, B. Rindi, Luisella Bosetti","doi":"10.2139/ssrn.967851","DOIUrl":"https://doi.org/10.2139/ssrn.967851","url":null,"abstract":"We study the effects of the introduction of a call auction in the closing stages of the trading day in Borsa Italiana's (BIt) equity markets. We show that the Closing Call Auction (CCA) drastically reduces spread and volatility just before the close of trading, while having a negligible effect on the rest of the day. We attribute this change in market quality to agents' reactions to the new trading opportunity offered by the CCA. We show that the introduction of a CCA significantly reduces the cost of immediacy at the end of continuous trading, and also reduces volatility. This effect is highly concentrated in the last few minutes of continuous trading, without any discernible impact on the rest of the day. To test the robustness of our findings, we compare this outcome with that of the introduction of the CCA on Euronext Paris and find similar results. The differences can be explained in the way the two exchanges calculate the Reference Price. We also document changes in the trading aggressiveness of various types of market participants around the close.","PeriodicalId":447775,"journal":{"name":"Capital Markets: Market Microstructure","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2007-02-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"129722300","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 contributes empirically to our understanding of informed traders. It analyzes traders' characteristics in a foreign exchange electronic limit order market via anonymous trader identities. We use six indicators of informed trading in a cross-sectional multivariate approach to identify traders with high price impact. More information is conveyed by those traders' trades which--simultaneously--use medium-sized orders (practice stealth trading), have large trading volume, are located in a financial center, trade early in the trading session, at times of wide spreads and when the order book is thin.
{"title":"Whose Trades Convey Information? Evidence from a Cross-Section of Traders","authors":"Lukas Menkhoff, Maik Schmeling","doi":"10.2139/ssrn.966091","DOIUrl":"https://doi.org/10.2139/ssrn.966091","url":null,"abstract":"This paper contributes empirically to our understanding of informed traders. It analyzes traders' characteristics in a foreign exchange electronic limit order market via anonymous trader identities. We use six indicators of informed trading in a cross-sectional multivariate approach to identify traders with high price impact. More information is conveyed by those traders' trades which--simultaneously--use medium-sized orders (practice stealth trading), have large trading volume, are located in a financial center, trade early in the trading session, at times of wide spreads and when the order book is thin.","PeriodicalId":447775,"journal":{"name":"Capital Markets: Market Microstructure","volume":"55 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2007-02-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"120900561","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}
Pub Date : 2007-01-29DOI: 10.1111/j.1467-6281.2007.00219.x
A. Frino, A. Lepone, Elvis Jarnecic
This article extends previous literature which examines the determinants of the price impact of block trades on the Australian Stock Exchange. As previous literature suggests that liquidity exhibits intraday patterns, we introduce time of day dummy variables to explore time dependencies in price impact. Following theoretical developments in previous literature, the explanatory power of the bid–ask spread, a lagged cumulative stock return variable and a refined measure of market returns are also examined. The model estimated explains approximately 29 per cent of the variation in price impact. Block trades executed in the first hour of trading experience the greatest price impact, while market conditions, lagged stock returns and bid–ask spreads are positively related to price impact. The bid–ask spread provides most of the explanatory power. This suggests that liquidity is the main driver of price impact.
{"title":"The Determinants of the Price Impact of Block Trades: Further Evidence","authors":"A. Frino, A. Lepone, Elvis Jarnecic","doi":"10.1111/j.1467-6281.2007.00219.x","DOIUrl":"https://doi.org/10.1111/j.1467-6281.2007.00219.x","url":null,"abstract":"This article extends previous literature which examines the determinants of the price impact of block trades on the Australian Stock Exchange. As previous literature suggests that liquidity exhibits intraday patterns, we introduce time of day dummy variables to explore time dependencies in price impact. Following theoretical developments in previous literature, the explanatory power of the bid–ask spread, a lagged cumulative stock return variable and a refined measure of market returns are also examined. The model estimated explains approximately 29 per cent of the variation in price impact. Block trades executed in the first hour of trading experience the greatest price impact, while market conditions, lagged stock returns and bid–ask spreads are positively related to price impact. The bid–ask spread provides most of the explanatory power. This suggests that liquidity is the main driver of price impact.","PeriodicalId":447775,"journal":{"name":"Capital Markets: Market Microstructure","volume":"41 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2007-01-29","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"114773796","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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