Excess demand and equilibration in multi-security financial markets: the empirical evidence

Price dynamics are studied in a dataset of more than 11,000 transactions from large-scale financial markets experiments with multiple risky securities. The aim is to determine whether a few simple principles govern equilibration. We first ask whether price changes are driven by excess demand. The data strongly support this conjecture. Second, we investigate the presence of cross-security effects (the excess demands of other securities influence price changes of a security beyond its own excess demand). We find systematic cross-security effects, despite the fact that transactions in one market cannot be made conditional on events in other markets. Nevertheless, stability is not found to be compromised in our data. A curious relationship emerges between the signs of the cross-effects and the signs of the covariances of the payoffs of the corresponding securities. It suggests a link between price discovery in real markets and the Newton procedure in numerical computation of general equilibrium. Next, we investigate whether the book (the set of posted limit orders) plays a role in the process by which excess demand becomes reflected in transaction price changes. We find strong correlation between excess demands and a weighted average of the quotes in the book. The correlation is far from perfect, and we document that our weighted average of the quotes in the book explains part of the variance of transaction price changes that is unaccounted for by excess demands.     

Biased Auctioneers

We construct a neural network algorithm that generates price predictions for art at auction, relying on both visual and nonvisual object characteristics. We find that higher automated valuations relative to auction house presale estimates are associated with substantially higher price-to-estimate ratios and lower buy-in rates, pointing to estimates' informational inefficiency. The relative contribution of machine learning is higher for artists with less dispersed and lower average prices. Furthermore, we show that auctioneers' prediction errors are persistent both at the artist and at the auction house level, and hence directly predictable themselves using information on past errors.     

Auctions vs. Bookbuilding and the Control of Underpricing in Hot IPO Markets

Market returns before the offer price is set affect the amountand variability of initial public offering (IPO) underpricing.Thus an important question is "What IPO procedure is best adaptedfor controlling underpricing in "hot" versus "cold" market conditions?"The French stock market offers a unique arena for empiricalresearch on this topic, since three substantially differentissuing mechanisms (auctions, bookbuilding, and fixed price)are used there. Using 1992–1998 data, we find that theauction mechanism is associated with less underpricing and lowervariance of underpricing. We show that the auction procedure'sability to incorporate more information from recent market conditionsinto the IPO price is an important reason.     

Short-sale refinancing and price adjustment speed to bad news: Evidence from a quasi-natural experiment in China

Short selling may accelerate stock price adjustment to negative news. However, the literature provides mixed evidence for this prediction. Using short-sale refinancing and a staggered difference-in-differences (DID) model, this paper explores the effect of short selling on stock price adjustment. Our results show that (1) short-sale refinancing improves the speed of stock price adjustment to negative news. This result holds after we control for endogeneity. (2) The positive relationship between short-sale refinancing and stock price adjustment speed is significant in subsamples of stocks with higher earnings management or lower accuracy of analyst forecasts, indicating that firms with more opaque information are more likely to be targeted by short sellers. In subsamples of stocks with a higher ownership concentration or lower ownership by institutional investors, short selling is more likely to increase the speed of stock price adjustment, indicating that ownership structure may influence negative news mining. (3) As short-sale refinancing exacerbates the absorption of bad news by stock prices, it increases crash risk. This study enriches the research on the economic consequences of short selling and provides empirical evidence supporting regulations on short selling in China.     

Regulating bidder participation in auctions

Regulating bidder participation in auctions can potentially increase efficiency compared to standard auction formats with free entry. We show that the relative performance of two such mechanisms, a standard first‐price auction with free entry and an entry rights auction, depends nonmonotonically on the precision of information that bidders have about their costs prior to deciding whether to participate in a mechanism. As an empirical application, we estimate parameters from first‐price auctions with free entry for bridge‐building contracts in Oklahoma and Texas and predict that an entry rights auction increases efficiency and reduces procurement costs significantly.     

Information precision and IPO pricing

This paper investigates the role of information precision in IPO pricing. The model shows that more precise information will exert more influence on the offer price. In strong support of the model, I find that the proportion of the industry return during the waiting period that is incorporated into the offer price increases with a proxy for the precision of the industry return as a measure of the change in the IPO firm's value during the waiting period. The model and the empirical findings enhance our understanding of the partial adjustment phenomenon: noisy information will be partially incorporated into the offer price.     

Bidding into the Red: A Model of Post-Auction Bankruptcy

This paper investigates auctions where bidders have limited liability. First, we analyze bidding behavior under different auction formats, showing that the second‐price auction induces higher prices, higher bankruptcy rates, and lower utilities than the first‐price auction. Second, we show that the cost of bankruptcy critically affects the seller's preference over the choice of auction. If bankruptcy is very costly, the seller prefers the first‐price auction over the second‐price auction. Alternatively, if the bankrupt assets are resold among the losers of the initial auction, the seller prefers the second‐price auction.     

Price discovery in auction markets: a look inside the black box

Opening mechanisms play a crucial role in information aggregationfollowing the overnight nontrading period. This article examinesthe process of price discovery at the New York Stock Exchangesingle-price opening auction. We develop a theoretical modelto explain the determinants of the opening price and test themodel using order-level data. We show that the presence of designateddealers facilitates price discovery relative to a fully automatedcall auction market. This is consistent with specialists extractinginformation from observing the evolution of the limit orderbook. In addition, the specialist's opening trade reflects noninformationalfactors such as price stabilization requirements.     

A Simple Measure of Price Adjustment Coefficients

One measure of market efficiency is the speed with which prices adjust to new information. We develop a simple approach to estimating these price adjustment coefficients by using the information in return processes. This approach is used to estimate the price adjustment coefficients for firms listed on the NYSE and the AMEX as well as for over-the-counter stocks. We find evidence of a lagged adjustment to new information in shorter return intervals for firms in all market value classes, and some support for the proposition that prices adjust much more slowly and with more noise for smaller firms.     

RULE CHANGES AND UNCERTAINTY IN DISCRIMINATORY AND UNIFORM PRICE AUCTIONS

The auction literature indicates that uncertainty about the value of auctioned goods increases underpricing in discriminatory price auctions. Such uncertainty has a smaller effect on uniform price auctions because the pricing rule aggregates bidders' information. We find that uncertainty resulting from inexperience with an auction mechanism has similar effects. Using initial public offering (IPO) data from Japan and Israel, we find that average underpricing increases temporarily in Japan's discriminatory price auctions after changes in the auction rules, which suggests that bidders reduce their bids in response to uncertainty. Underpricing in Israel's uniform price auctions is not affected by rule changes.     

Margin trading and price efficiency: information content or price-adjustment speed?

The literature offers contradictory views on the effect of margin-trading activities on price efficiency. Based on data from a Chinese margin-trading pilot programme in 2010, we separate price efficiency into information content and price-adjustment speed and investigate the effect of margin-trading activity on price efficiency. We find that after adding to the eligible list, pilot stocks experience a decrease in information content, but an increase in price-adjustment speed. Furthermore, increased margin-buying activities are associated with lower information content, but faster price adjustment. Our results reconcile the debate over the effect of margin trading on price efficiency.     

Nominal shocks in monopolistically competitive markets: An experiment

A market experiment examines the capacity of price and information frictions to explain real responses to nominal price shocks. Results indicate that both price and information frictions impede the response to a nominal shock, as predicted by the standard dynamic adjustment models. Observed adjustment delays, however, far exceed predicted levels. Results of a pair of subsequent treatments indicate that a combination of announcing the shock privately to all sellers (rather than publicly) and a failure of many sellers to best respond to their expectations explains the observed adjustment inertia.     

On the Welfare Gains of Price Dispersion

Can price dispersion be associated with higher levels of welfare? To answer we compare two economies that differ only in the way prices are formed. In the first, sellers post a unique price–quantity pair, with no price dispersion. In the second, sellers post a quantity only and let prices be determined ex post by realized demand, resulting in price dispersion. We show that while agents trade lower quantities when prices are dispersed (an intensive margin effect), they also trade more often (an extensive margin effect). At low inflation, the extensive margin dominates making agents better off with price dispersion.     

Order book approach to price impact

Buying and selling stocks causes price changes, which are described by the price impact function. To explain the shape of this function, we study the Island ECN orderbook. In addition to transaction data, the orderbook contains information about potential supply and demand for a stock. The virtual price impact calculated from this information is four times stronger than the actual one and explains it only partially. However, we find a strong anticorrelation between price changes and order flow, which strongly reduces the virtual price impact and provides for an explanation of the empirical price impact function.     

Price-Formation Process of an Emerging Futures Market: Call Auction Versus Continuous Auction

This study assesses the market qualities of alternative price-formation processes for an emerging futures market—the Taiwan futures market. In 2002, the price formation process in the market changed during the period of trade between call auction and continuous auction. The performances of call auction and continuous auction are compared using intraday data. Empirical results show that the market is more liquid, and volatility is slightly lower, under continuous auction than under call auction. Also, there is robust evidence that continuous auction improves informative efficiency. The study suggests that for an emerging futures market like that of Taiwan, continuous auction offers a better trading environment for futures trading. In addition to demonstrating the virtue of continuous auction, this study also finds that the asymmetry in volatility is related to the price formation process. The asymmetry effect exists under continuous auction, but not under call auction.     

Investment analysis and the adjustment of stock prices to common information

In this article we are concerned with the effect of the numberof investment analysts following a firm on the speed of adjustmentof the firm's stock price to new information that has commoneffects across firms. It is found that returns on portfoliosof firms that are followed by many analysts tend to lead thoseof firms that are followed by fewer analysts, even when thefirms are of approximately the same size. Many analyst firmsalso tend to respond more rapidly to market returns than dofew analyst firms, adjusting for firm size. This relation, however,is nonlinear, and the marginal effect of the number of analystson the speed of price adjustment increases with the number ofanalysts.     

Timing of Sale,Pricing, and Cost Information: Evidence from the Airline Industry*

This study examines the association between when an airline sells its passenger seats and the pricing method (marginal cost or full cost) it employs. Prior literature suggests that when firms are able to change prices during the selling period, the optimality of full cost pricing or marginal cost pricing depends on when demand information is revealed during the period between capacity commitment decisions and time of sale. Full cost‐based pricing is appropriate in determining capacity commitment and prices simultaneously, while marginal cost provides more relevant information for pricing when capacity has been committed. Using the price and cost data from a sample of four U.S. domestic airlines, we find that full cost explains price variations of first‐day sales robustly. The adjusted R² of the marginal cost pricing model is larger in the sample of sales two days prior to departure than in the sample of first‐day sales. In the analysis of the sample of sales two days prior to departure, we find that, based on the adjusted R² of the full cost pricing and marginal cost pricing models, the explanatory power of marginal cost pricing is relatively weaker than full cost pricing. Our results document the use of different cost information along the dynamic change of price and provide implications in understanding the role of cost information in setting prices.     

Auctions with heterogeneous entry costs

If bidders have independent private values and homogeneous entry costs, a first‐ or second‐price auction with a reserve price equal to the seller’s value maximizes social surplus and seller revenue. We show that if entry costs are heterogeneous and private information, then the revenue‐maximizing reserve price is above the seller’s value, a positive admission fee (and a reserve price equal to the seller’s value) generates more revenue, and an entry cap combined with an admission fee generates even more revenue. Social surplus and seller revenue may either increase or decrease in the number of bidders, but they coincide asymptotically.     

The Effect of Trading Halts on the Speed of Price Discovery

Trading halts are aimed at reducing information asymmetry by granting investors the opportunity to reassess trades upon arrival of new, substantial information. This study is the first to address the efficiency of the price discovery process with respect to time, i.e., the speed of adjustment to new information. A unique database allow us to conduct an event study analysis and measure the impact of trading halts on price discovery while controlling for content, operational and value effects. We find that information dissemination following trading halts is over 40% faster and that abnormal trading activity is positively related to the speed of price adjustment.