Efficient trading with nonlinear utility

In an environment in which agents have nonlinear utility and sufficiently asymmetric initial endowments, we show that efficient trading is achievable. This result is in contrast with Myerson and Satterthwaite (1983), which shows efficient trading is not possible if agents have linear utility and asymmetric initial endowments. Our result is also different from Cramton et al. (1987), in which they maintain the linear utility assumption as in Myerson and Satterthwaite but assume that traders’ initial endowments are relatively symmetric.     

Stock market dynamics with institutional trading

In this paper, the impact of institutional trading on stock market dynamics is analysed. We study the problem in an abstract context in which stocks of only one type are traded and institutions' portfolio choices are simply restricted to the partition of portfolio between stocks and bonds; in this simplified context it is shown how institutions' monitoring of individual investors' potentially destabilizing behavior (hearding and positive-feedback behavior) can be effective to obtain stock market stability.

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Sommario In questo articolo abbiamo analizzato la dinamica del mercato azionario in presenza di fondi di investimento. A tal fine, è stato proposto e studiato un modello dinamico che evidenzia alcuni nessi causali fra le scelte dei fondi e le scelte degli investitori non istituzionali.

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While remaining fully rsponsible for this paper, I thank Marcello Galeotti, Antonio Gay and Franco Gori for insightful comments and suggestions.     

Link-save trading

Transaction costs involved while trading several assets may be described using bid-ask spread of the asset prices. We assume that the prices of several assets may be linked, so that transactions involving several assets have prices that are not necessarily equal to the sums of (bid or ask) prices of the individual assets. The family of possible price combinations forms a convex (random) set which changes in time and is called the set-valued price process. It is shown that the necessary and sufficient condition for no-arbitrage is the existence of a martingale selection, i.e. a martingale that takes values in the set-valued price process. Examples and applications to option pricing are discussed.     

Two-period model of insider trading with correlated signals

In this article, we extend the one-period model of Jain and Mirman (1999) for asset trading with two correlated signals to a two period model. We then prove the existence and uniqueness of the Bayesian linear equilibrium. Finally, we perform comparative statics analysis with respect to Kyle (1985). Our findings reveal that adding another correlated signal (the real signal) to the total order flow of Kyle (1985), increases the amount of information incorporated in the stock price at each period and decreases the insider’s expected profits at each period.     

Cournot duopoly and insider trading with two insiders

We study the effect of competition among insiders in an extension of the static Kyle [Kyle, A. (1985). Continuous auctions and insider trading. Econometrica, 53, 1315–1335] model of insider trading introduced by Jain and Mirman (JMC) [Jain, N., & Mirman, L.J. (2002). Effects of insider trading under different market structures. The Quarterly Review of Economics and Finance, 42, 19–39]. In the JMC model competition in the real sector is introduced. In this paper we introduce competition in the stock sector in the JMC model by assuming that there is a manager who is responsible for making the real decisions of the firm as well as an ‘owner’ who has the same information as the manager but has no managerial responsibilities. In this way we can study the interaction between competition in the real sector and competition in the financial sector. We show that the stock price set by the market makers reveals more information than in the JMC model and that the expected equilibrium values of the manager’s profits sometimes decline and sometimes increase depending on the exogenous parameters of the model. Moreover, we prove that due to the competition in the financial sector, the level of output produced by the firm is less than in JMC. Finally, we also study the effect of financial competition in the case in which the market makers receive only one signal and analyze the comparative statics in this case.     

Experimental evidence on trading behavior,market efficiency and price formation in double auctions with unknown trading duration

The reasons for the highly efficient market outcomes observed under the double auction remain unclear. This paper presents a series of experimental financial markets designed to investigate the importance of unknown trading period duration on trading behavior and the convergence tendencies of such markets. Using panel data techniques the results support the conclusions that individuals generally display more aggressive trading strategies, trading earlier in a period, and that markets exhibit reduced levels of informational efficiency when unknown duration is present. Markets with imperfect information structures are also studied and, in a unique result, are associated with significantly slower rates of trade, as traders become more cautious over their trading strategies. Investigation of the price formation process provides evidence that the pricing error varies over time and the estimation of a fixed effects model provides unique support that learning effects and unknown trading period duration influence the price formation process. Future refinement of theoretical models of the price formation process or institutions of exchange should recognize the effect of unknown trading period duration on market behavior, along with potential learning effects. Copyright © 2005 John Wiley & Sons, Ltd.     

Stock volatility and trading

Both, rational and behavioral models predict that stock and market volatility affect trading by investors. Tax-induced trading hypothesis predicts that investors increase realization of capital losses short term and capital gains only long term as volatility increases. Behavioral models predict that disposition biases of holding on to losers and disposing of winners intensifies with volatility. We document that market and stock volatility influence stock trading. Evidence on trading in response to rise in market volatility supports tax-loss harvesting hypothesis – abnormal trading of losers increases and winners decreases. However, evidence on trading patterns conditional on individual stock volatility is in support of both tax-loss-harvesting and behavioral models: trading in both losing stocks (tax-loss-harvesting hypothesis) and winning stocks (disposition effect hypothesis) increases with rise in stock volatility.     

When continuous trading becomes continuous: The impact of institutional trading on the continuous trading system of the Warsaw Stock Exchange

This paper examines the impact of a large increase in the number of institutional traders on the performance of a continuous trading system using Polish stock market data. After the Polish pension reform in 1999, the domestic stock market experienced large inflows of money. We theoretically and empirically show that those stocks that are actively traded by pension funds display increases in the share of continuous trading and corresponding liquidity in this system, while no positive effects are found for other stocks. Moreover, we find spill-over effects to the call auction system.     

Costly arbitrage through pairs trading

We study the optimal trading policy of an arbitrageur who can exploit temporary mispricing in a market with two convergent assets. We build on the model of Liu and Timmermann (2013) and include transaction costs, which impose additional limits to the implementation of such convergence trade strategy. We show that the presence of transaction costs could reveal an endogenous stop-loss concern in a certain economy, which affects the optimal policy of the arbitrageur in significant ways. Using pairs of dual-listed Chinese stock shares as samples and a pairs trading strategy based on standard deviation of the spread as benchmark, we demonstrate the efficiency of the strategy implied by our model. Several extensions of our model are also discussed.     

Spurious regressions in technical trading

This paper investigates the spurious effect in forecasting asset returns when signals from technical trading rules are used as predictors. Against economic intuition, the simulation result shows that, even if past information has no predictive power, buy or sell signals based on the difference between the short-period and long-period moving averages of past asset prices can be statistically significant when the forecast horizon is relatively long. The theoretical analysis reveals that both ‘momentum’ and ‘contrarian’ strategies can be falsely supported, while the probability of obtaining each result depends on the type of the test statistics employed.     

Derivative trading by utility firms

This paper examines the use of derivatives by a utility company. The hedging problem for utilities is atypical; the goal is not strictly to minimize average costs. Rather, the objectives are to minimize the upside risk associated with extreme bills, volatility of bills, and average expected bills for consumers. We characterize the optimal positions on futures contracts and options on futures that a utility company should assume. The results indicate that the use of derivatives (both futures and options on futures) is an efficient means of optimizing the objective functions without exposing consumers to speculative risk.     

Insider trading and performance of seasoned equity offering firms after controlling for exogenous trading needs

Insiders trade not only because they have private information about their companies but also because of other exogenous reasons. Therefore, it is important to control for exogenous trading needs in empirical studies regarding insider trading. Lee (1997) shows that insider trading is not closely related to the long-term performance of primary seasoned equity offering firms. This paper examines whether the results hold after controlling for exogenous needs to trade by using an inequality test with instrumental-variables technique.     

Day trading and stock price volatility

When an investor buys and sells the same stock on the same day, he is said to have made a day trade. Using the trading records of Finnish traders, this paper examines whether day trading is related to volatility of stock prices. I find a strong positive time-series relation between the number of day trades by individual investors and intraday volatility among heavily day traded stocks. This effect is robust after controlling for a previously documented volume–volatility relation. The result suggests that the joint hypothesis of price pressure and volatility induced day trading dominates the liquidity effects of day trading.     

Excessive banking preference in emissions trading

Firms tend to bank permits excessively, resulting in a lack of supply in the market and uncertainty regarding the ability to achieve the planned emissions target. This excessive banking preference is difficult to explain in terms of rational cost minimization for regulatory compliance. This study provides hypotheses to explain banking preference using cognitive bias concepts such as prospect theory, mental accounting, and regret aversion. The hypotheses are supported by three survey-based experiments. This view of cognitive bias on banking preference justifies the use of active measures to prevent excessive banking, such as market makers and market restrictions.     

Endogenous trading in credit default swaps

We introduce a real options model in order to quantify the moral hazard impact of credit default swap (CDS) positions on the corporate default probabilities. Moral hazard is widely addressed in the insurance literature, where the insured agent may become less cautious about preventing the risk from occurring. Importantly, with CDS the moral hazard problem may be magnified since one can buy multiple protections for the same bond. To illustrate this issue, we consider a firm with the possibility of switching from an investment to another one. An investor can influence the strategic decisions of the firm and can also trade CDS written on the firm. We analyze how the decisions of the investor influence the firm value when he is allowed to trade credit default contracts on the firm’s debt. Our model involves a time-dependent optimal stopping problem, which we study analytically and numerically, using the Longstaff–Schwartz algorithm. We identify the situations where the investor exercises the switching option with a loss, and we measure the impact on the firm’s value and firm’s default probability. Contrary to the common intuition, the investors’ optimal behavior does not systematically consist in buying CDSs and increase the default probabilities. Instead, large indifference zones exist, where no arbitrage profits can be realized. As the number of the CDSs in the position increases to exceed several times the level of a complete insurance, we enter in the zone where arbitrage profits can be made. These are obtained by implementing very aggressive strategies (i.e., increasing substantially the default probability by producing losses to the firm). The profits increase sharply as we exit the indifference zone.     

Commodity money equilibrium in a convex trading post economy with transaction costs

Existence and efficiency of general equilibrium with commodity money is investigated in an economy where N   commodities are traded at N(N−1)/2$N(N-1)/2$ commodity-pairwise trading posts. Trade is a resource-using activity recovering transaction costs through the spread between bid (wholesale) and ask (retail) prices. Budget constraints, enforced at each trading post separately, imply demand for a carrier of value between trading posts. Existence of general equilibrium is established under conventional convexity and continuity conditions while structuring the price space to account for distinct bid and ask price ratios. Commodity money flows are identified as the difference between gross and net inter-post trades.     

Insider trading around open-market share repurchases

We examine insider trading around open-market share repurchases and find that insiders trade passively in 3 months prior to repurchase announcements and in up to 12 months following the announcements. Furthermore, both pre-announcement and post-announcement abnormal insider trading is unrelated to short-term announcement returns but correlated with long-term post-announcement returns. Our results indicate that corporate insiders trade passively around repurchase announcements in accordance with their perceived undervaluation to exploit the long-run abnormal stock returns related to the events.     

Extreme returns and intensity of trading

Asymmetric information models of market microstructure claim that variables such as trading intensity are proxies for latent information on the value of financial assets. We consider the interval‐valued time series (ITS) of low/high returns and explore the relationship between these extreme returns and the intensity of trading. We assume that the returns (or prices) are generated by a latent process with some unknown conditional density. At each period of time, from this density, we have some random draws (trades) and the lowest and highest returns are the realized extreme observations of the latent process over the sample of draws. In this context, we propose a semiparametric model of extreme returns that exploits the results provided by extreme value theory. If properly centered and standardized extremes have well‐defined limiting distributions, the conditional mean of extreme returns is a nonlinear function of the conditional moments of the latent process and of the conditional intensity of the process that governs the number of draws. We implement a two‐step estimation procedure. First, we estimate parametrically the regressors that will enter into the nonlinear function, and in a second step we estimate nonparametrically the conditional mean of extreme returns as a function of the generated regressors. Unlike current models for ITS, the proposed semiparametric model is robust to misspecification of the conditional density of the latent process. We fit several nonlinear and linear models to the 5‐minute and 1‐minute low/high returns to seven major banks and technology stocks, and find that the nonlinear specification is superior to the current linear models and that the conditional volatility of the latent process and the conditional intensity of the trading process are major drivers of the dynamics of extreme returns.     

期货市场程序化交易研究

随着我国金融市场的繁荣发展,期货市场也呈现出快速发展的趋势,但是由于期货市场分布比较散乱,交易的种类和程序存在着很大的差异,导致期货市场风险居高不下。