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L earning from Trading

L earning from Trading . שאלות המחקר. Do Corporate Bonds’ Prices adjust to information about their Changes in the deviation from the price dictated by their rating ? Do the prices react to public information that has merely been re-packed?

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L earning from Trading

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  1. Learning from Trading

  2. שאלות המחקר • Do Corporate Bonds’ Prices adjust to information about their Changes in the deviation from the price dictated by their rating ? • Do the prices react to public information that has merely been re-packed? • If so, what is the shape of the Price Discovery Process (PDP)? • How different is the speed of the PDP over rates and classes? (liquid/illiquid; Linked/straight)? • Can we identify the factors behind the PDP and it’s speed /quality of convergence ?

  3. The Semi strong form “The semi-strong-form (of EMH) claims both that prices reflect all publicly available information and that prices instantly change to reflect new public information” (Fama, 1965)

  4. Key findings • Markets react, prices change reflecting data that is merely restructuring of known prices

  5. סקירת הספרות • markets learn from previous trading in order to bridge asymmetrical gaps. In the debt market, the corporations are not typically the wellspring of private information. The more common fountainheads of the asymmetric information are the Central Bank (Benabou and Gertner 1994), the market structure (Drudi and Massa 2005) and recursive settings, such as Index announcements (Kandel, Ofer and Sarig 1993). • Hotchkiss and Ronen (2002):The informational efficiency of high-yield bonds is as good as that of the related stocks. These findings contradict previous results (Cornell and Green 1991; Kwan 1996) • Green (2004) finds a significant increase in the informational role of trading following economic announcements • Ronen and Zhou (2006) analyze price behavior around earnings releases and show that information is incorporated into rated corporate bonds almost as quickly as into stock prices. • Amihud and Mendelson (1986,1987,) AmihudMendelsonand Pederson (2005) develop a model to measure the cost of illiquidity. Bao, Pan and Wang (2011) suggest an empirical test to measure the impact of illiquidity in markets without bid/ask spread.

  6. השוק • RBT publish, every Thursday afternoon a series of yield-to-maturity matrices for institutional investors. • The YTM matrices allow traders to compute the FVP of any debt, including traded bonds. • When trading commence on Sunday morning, the extracted prices can serve as benchmarks.

  7. בסיס הנתונים • Sundays data: Jan 2006-Dec 2007 (after the institutional investors incorporate RBT’s system and prices • Data set :Rated and Traded corporate bonds (AA to A-); A total of 176 traded bonds (Dec 2007) • Filtering out CPI announcements of Thur./Fri. • For each bond we compute the Fair Value using RBT’s YTM matrices (t is provided in ¼ year intervals)

  8. בסיס הנתונים (המשך) Each bond is stripped such that the Fair Value Price(FVP) of an m-period bond making a series of coupon payments c every period and with redemption value N can be computed by: Market prices are sampled every 2 / 5 minutes over the first 120 minutes of trade.

  9. מודל For each cluster, we regress the bond price change against the surprise component of the model announcement: For each bond, we regress the changes in the price against the surprise component of the model announcement: Where and denotes the surprise component in the jth model. announcements, j bonds and denotes a certain point in time after the announcement is released. In our work is fixed as the information is revealed simultaneously for all the assets.  Mistake! Should be regress !

  10. הטיעון: When market players observe the FVP as sufficiently accurate they trade, with the view of fitting the bonds’ prices to the FVP. Players would use the model prices as a benchmark if either: • They believe that model prices reflect more genuinely assets’ prices than market prices do, or; • They use the model prices as a benchmark and are willing to trade at the fair value price if they can buy or sell while the Fair Value price is lower or higher than the trader’s private price. • Price discovery can be described as a feedback: Traders hold both traded and non-traded bonds; Price discovery acts as “Communicating Vessels” process between the two clusters.

  11. Examples

  12. Price Discovery Process: absolute value, normalized, accumulated

  13. High vol. vs Low vol. PDP

  14. Communicating Vessels, liquid bonds

  15. נקודות לדיון • The Fair Value Price is an anchor for the market. We show that the majority of the portfolios converge to the portfolio’s FVP • the binding factor for the speed of the PDP is liquidity • Other factors such as rating and CPI-linkage are not significant. • Using new, a theoretically motivated measure of illiquidity: the amount of price reversals as captured by the negative of auto-covariance of prices changes, we show that illiquidity is both statistically and economically significant for a broad cross-section of corporate bonds.

  16. Variance of the tracking error: RF vs. AA bonds

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