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on Market Microstructure |
| By: | Cespa, Giovanni; Vives, Xavier |
| Abstract: | We propose a theory that jointly accounts for an asset illiquidity and for the asset price potential over-reliance on public information. We argue that, when trading frequencies differ across traders, asset prices reflect investors' Higher Order Expectations (HOEs) about the two factors that influence the aggregate demand: fundamentals information and liquidity trades. We show that it is precisely when asset prices are driven by investors' HOEs about fundamentals that they over-rely on public information, the market displays high illiquidity, and low volume of informational trading; conversely, when HOEs about fundamentals are subdued, prices under-rely on public information, the market hovers in a high liquidity state, and the volume of informational trading is high. Over-reliance on public information results from investors' under-reaction to their private signals which, in turn, dampens uncertainty reduction over liquidation prices, favoring an increase in price risk and illiquidity. Therefore, a highly illiquid market implies higher expected returns from contrarian strategies. Equivalently, illiquidity arises as a byproduct of the lack of participation of informed investors in their capacity of liquidity suppliers, a feature that appears to capture some aspects of the recent crisis. |
| Keywords: | Average expectations; Beauty Contest; Expected returns; Multiple equilibria; Over-reliance on public information |
| JEL: | G10 G12 G14 |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:8303&r=mst |
| By: | Douglas Gale; Tanju Yorulmazer |
| Abstract: | Banks hold liquid and illiquid assets. An illiquid bank that receives a liquidity shock sells assets to liquid banks in exchange for cash. We characterize the constrained efficient allocation as the solution to a planner’s problem and show that the market equilibrium is constrained inefficient, with too little liquidity and inefficient hoarding. Our model features a precautionary as well as a speculative motive for hoarding liquidity, but the inefficiency of liquidity provision can be traced to the incompleteness of markets (due to private information) and the increased price volatility that results from trading assets for cash. |
| Keywords: | Bank liquidity ; Bank assets ; Interbank market |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:488&r=mst |
| By: | Ennio Bilancini; Leonardo Boncinelli |
| Abstract: | In this paper we examine the problem of dynamic adverse selection in a stylized market where the quality of goods is a seller’s private information. We show that in equilibrium all goods can be traded if a simple piece of information is made publicly available: the size of the informed side of the market. Moreover, we show that if exchanges can take place frequently enough, then agents roughly enjoy the entire potential surplus from exchanges. We illustrate these findings with a dynamic model of trade where buyers and sellers repeatedly interact over time. More precisely we prove that, if the size of the informed side of the market is a public information at each trading stage, then there exists a weak perfect Bayesian equilibrium where all goods are sold in finite time and where the price and quality of traded goods are increasing over time. Moreover, we show that as the time between exchanges becomes arbitrarily small, full trade still obtains in finite time – i.e., all goods are actually traded in equilibrium – while total surplus from exchanges converges to the entire potential. These results suggest two policy interventions in markets suffering from dynamic adverse selection: first, the public disclosure of the size of the informed side of the market in each trading stage and, second, the increase of the frequency of trading stages. |
| Keywords: | dynamic adverse selection; full trade; size of the informed side; frequency of exchanges; asymmetric information |
| JEL: | D82 L15 |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:mod:recent:057&r=mst |
| By: | Ben-David, Itzhak (OH State University); Franzoni, Francesco (Swiss Finance Institute and University of Ligano); Landier, Augustin (Toulouse School of Economics); Moussawi, Rabih (University of PA) |
| Abstract: | We find evidence of significant price manipulation at the stock level by hedge funds on critical reporting dates. Stocks in the top quartile by hedge fund holdings exhibit abnormal returns of 30 basis points in the last day of the month and a reversal of 25 basis points in the following day. Using intraday data, we show that a significant part of the return is earned during the last minutes of the last day of the month, at an increasing rate towards the closing bell. This evidence is consistent with hedge funds' incentive to inflate their monthly performance by buying stocks that they hold in their portfolios. Higher manipulations occur with funds that have higher incentives to improve their ranking relative to their peers and a lower cost of doing so. |
| Date: | 2011–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:ohidic:2011-5&r=mst |