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Information and Market Microstructure

Information and Market Microstructure. Chaoyang University of Technology Department of Finance Ming-Chin Lin. Outline. Part I The Literature Part II Empirical Observations Part III From Idea to Writing. Part I The Literature.

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Information and Market Microstructure

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  1. Information and Market Microstructure Chaoyang University of Technology Department of Finance Ming-Chin Lin

  2. Outline Part I The Literature Part II Empirical Observations Part III From Idea to Writing

  3. Part I The Literature • Grossman and Stiglitz (AER, 1980) • Kyle (Econometrica, 1985)

  4. Grossman and Stiglitz (AER, 1980) • Joint normality of signals and payoffs – Exponential Utility – Linear demand functions – Normally distributed price • Rational Expectations – Traders use correct models

  5. Grossman and Stiglitz Model: Only Informed Traders • Informed Traders – Continuum of identical traders – Risk Averse with exponential utility – Private signal = value + noise – Rational – Perfect Competitors – Condition on Price

  6. Assumptions

  7. Grossman and Stiglitz Model: AddUninformed Traders • Uninformed Traders (= Market Makers) – Continuum of identical traders – Risk Averse with Exponential Utility – Continuum of Perfect Competitors – Condition on Price • Could stop here (no other traders) – Price = weighted average of “signal” and “prior” mean – Private information can be inferred from price

  8. Information Acquisition Puzzle

  9. Grossman and Stiglitz Model: AddNoise Traders •“Noise traders” : Who are they? – Random endowment, hedging – Liquidity needs • Optimization by noise traders not modeled

  10. Problem with Competitive Models • Large traders affect prices and know they affect prices. • G&S impossibility results if perfect competition assumed.

  11. Kyle (Econometrica, 1985): Single-Period Model • Informed Trader – Monopolist, exercises monopoly power – Risk Neutral • Market order model: This model

  12. • Uninformed Traders = Market Makers – Perfect Competitors – Risk Neutral • Take other side of market orders • Noise Traders trade randomly as in G&S. • Microstructure: Informed and noise trades batched, anonymously.

  13. Kyle (1985): Equilibrium •Informed trader maximizes profits (quadratic problem): x = β*(V-P) • Pricing Rule: P = E{V | order flow = x + noise} = u + λ * [order flow]

  14. •Equilibrium: 1/λ = [market depth] = stdev(noise) / stdev(V) β = [market depth]/2 • Price Informativeness Var(V|P) = ½ Var(V)

  15. Bid – Ask Spread: Order flow = -1, market maker sets bid price = u + λ(-1) = u –λ Order flow = 1, market maker sets ask price = u + λ

  16. 1/λ = [market depth] = stdev(noise) / stdev(V) • stdev(noise) • stdev(V) φ=1/2 1-φ=1/2 q 1-q

  17. Maug (JF, 1998)

  18. Maug’s Definition of Market Depth the degree in which a trade moves the price λ = E(P|B) – E(P|S) / H - L λ= 0, infinitely deep market; λ= 1, fully revealing Market Depth : the probability that market prices are not fully revealing = 1- λ= 1/2

  19. Why does “liquidity” matter ? market liquidity is essential in finance literature The idealized assumptions : - frictionless - perfectly liquid markets (traded at no cost) - agents take prices as given.

  20. If markets are not frictionless and are disturbed by some form of illiquidity? Moreover, if the assumptions thatprice-taking investors have the same information and are present in the market at all times are relaxed?

  21. create an adverse selection problem that implies differing bid and ask prices set by market maker. In this case, market liquidity is priced by the bid/ask spread and the competitive equilibrium can not be applied.

  22. Remark: Market Microstructure Loose Definition: examining the process by which securities are traded affects prices, volume and trading behavior Key concepts: market efficiency market liquidity

  23. Order Driven Market

  24. Quote Driven Market

  25. Empirical Studies:Decompose bid-ask spread - Order Processing Costs - Inventory Costs - Adverse Selection Costs

  26. Part II Empirical Observations Monetary Liquidity - in the sense of monetary factors, monetary policy Market Liquidity - measured by transaction costs, trading volume, turnover rate, bid-ask spread, market depth

  27. Monetary policy  Asset Prices Monetary policy  Market Liquidity

  28. Fig.1 Fedtarget federal funds rate Source : Monetary Policy Report to the Congress July 15, 2004

  29. Fed target federal funds rate (cont.) Source : Monetary Policy Report to the Congress Feb. 24, 2009

  30. Fig. 2 Interest rate Source : Monetary Policy Report to the Congress Feb. 24, 2009

  31. Fig.3 NYSE Turnover rate Source : NYSE

  32. NYSE Turnover rate (cont.)

  33. Fig.4 CBOE VIX Index(a measure of equity market volatility)

  34. VIX Index 2007-2009(cont.)

  35. 從實際資料觀察 圖一和圖二來看, 當 目標利率調高的同時, 30天期商業本票報酬率也走高. 但若觀察圖三和圖四－反映市場流動性的指標－則似乎和圖一並沒有明顯的關係。

  36. 然而若我們縮小範圍，觀察某一段特定時間的變化，又會有一些新發現。然而若我們縮小範圍，觀察某一段特定時間的變化，又會有一些新發現。 1. 2006年 5~6 月份 油價高漲造成通膨壓力，市場預期 FOMC 持續調升利率的機率很高，此時的週轉率低 (圖三) 而波動程度高 (圖四)； 2. 2007 年 8~9 月份 因為次級房貸危機造成經濟下跌的隱憂，市場預期 FOMC 持續調降利率的機率很高，此時的週轉率高 (圖三) 而波動程度低 (圖四)

  37. 此觀察結果似乎指出 monetary policy and market liquidity 存在某種關聯。 從實證研究的結果的確發現二者之間的聯繫。

  38. Empirical Findings Chordia, Roll and Subrahmanyam (JF, 2001) Depth rises prior to macroeconomic data release and falls back toward its normal level on the day of announcement.

  39. Empirical Findings Chordia, Sarkar and Subrahmanyam (RFS, 2005) They found monetary expansion increases (decreases) in the federal fund rate lead to decreases (increases) in liquidity and increases (decreases) in stock and bond volatility.

  40. 上述屬於實證研究，然關於理論方面的研究則尚不多見。上述屬於實證研究，然關於理論方面的研究則尚不多見。 因此不論是觀察實際資料或是實證研究的結果都指出建立 macro liquidity and market liquidity 之理論關係是值得探討的議題。

  41. An Example We focus on the transmission mechanisms : from “market expectation about monetary stance of the Fed” to “market liquidity in terms of adverse selection costs”

  42. Why is the linkage so important? • 如果藉由理論探討所提供的各種可能結果，能夠了解貨幣政策將如何影響市場流動性，對於中央銀行制定貨幣政策以及進行公開市場操作時是很重要的參考。 • 市場流動性影響價格揭露訊息的程度，透過不同水準的市場流動性可以映照出市場對於貨幣政策的預期看法和對基本面的信心。

  43. Microstructure Model 藉由Kyle (1985) and Maug (1998)模型探討： market maker 因為考慮面臨informed traders 產生的逆選擇問題所訂定的交易價格，在加入了市場對貨幣政策的預期看法後，將會有什麼影響？

  44. 藉此模型回答如下問題： if market beliefs about the Fed policy change, how will the informativeness of price be affected? Will the market depth or the adverse selection be more serious?

  45. Part III From Idea to Writing Presentation需要注意哪些 • 引起聽眾的興趣和注意 • 以直覺的方式表達 • 文章打散再重組 • 技術性的地方可以省略 • 不需太花俏

  46. Idea 怎麼來 • 敏銳而細膩的觀察 – 對現象的關注 • 深刻而嚴密的思考 – 對事理的分析 • 活潑而豐富的想像 – 對本質的好奇 • 抽象與具體的轉換 – 對方法的熟稔

  47. 養分的來源 • 小說 電影 不同形式的藝術創作 • 報章 雜誌 隨處可得的網路資訊 • 不同領域成功或失敗的故事 • 自己生活中的體會

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