The microstructure of the U.S. treasury market

This article discusses the microstructure of the U.S. Treasury securities market. Treasury securities are nominally riskless debt instruments issued by the U.S. government. Microstructural analysis is a field of economics/finance that examines the roles played by heterogenous agents, institutional detail, and asymmetric information in the trading process. The article describes types of Treasury issues; stages of the Treasury market; the major players, including the role of the Federal Reserve Bank of New York and the interdealer brokers; the structure of both the spot and futures markets; the findings of the seasonality/announcement and order book literature; and research on price discovery. We conclude by discussing possible future avenues of research.Government securities

Information shares in the U.S. treasury market

This paper is the first to characterize the tatonnement of high-frequency returns from U.S. Treasury spot and futures markets. In particular, we highlight the previously neglected role of the futures markets in price discovery. The lower-bound estimate of bivariate information shares for 30-year Treasury futures typically exceeds 50% from 1998 on. Standard liquidity measures, including the proportion of trades and relative bid-ask spreads, explain daily information shares. These conclusions still hold when one controls for days of macroeconomic announcements. Finally, a 5-dimensional cointegrated system explains a high percentage of Treasury returns. In that system, the 30-year futures contract and the 5-year spot market dominate price discovery. ; Earlier title: The microstructure of bond market tatonnement; Price discovery in the U.S. treasury marketBond market

The Rise of Computerized High Frequency Trading: Use and Controversy

Over the last decade, there has been a dramatic shift in how securities are traded in the capital markets. Utilizing supercomputers and complex algorithms that pick up on breaking news, company/stock/economic information and price and volume movements, many institutions now make trades in a matter of microseconds, through a practice known as high frequency trading. Today, high frequency traders have virtually phased out the dinosaur floor-traders and average investors of the past. With the recent attempted robbery of one of these high frequency trading platforms from Goldman Sachs this past summer, this rise of the machines has become front page news, generating vast controversy and discourse over this largely secretive and ultra-lucrative practice. Because of this phenomenon, those of us on Main Street are faced with a variety of questions: What exactly is high frequency trading? How does it work? How long has this been going on for? Should it be banned or curtailed? What is the end-game, and how will this shape the future of securities trading and its regulation? This iBrief explores the answers to these questions

An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies

Recent advances in financial theory have created an understanding of the environments in which a real security can be synthesized by a dynamic trading strategy in a risk free asset and other securities. We contend that there is a crucial distinction between a synthetic security and a real security, in particular the notion that a real security is redundant when it can be synthesized by a dynamic trading strategy ignores the informational role of real securities markets. The replacement of a real security by synthetic strategies may in itself cause enough uncertainty about the price volatility of the underlying security that the real security is no longer redundant. Portfolio insurance provides a good example of the difference between a synthetic security and a real security. One form of portfolio insurance uses a trading strategy in risk free securities ("cash") and index futures to synthesize a European put on the underlying portfolio. In the absence of a real traded put option (of the appropriate striking price and maturity), there will be less information about the future price volatility associated with current dynamic hedging strategies. There will thus be less information transmitted to those people who could make capital available to liquidity providers. It will therefore be more difficult for the market to absorb the trades implied by the dynamic hedging strategies, In effect, the stocks' future price volatility can rise because of a current lack of information about the extent to which dynamic hedging strategies are in place.

Impact of Electronic Trading Platforms on the Brokered Interdealer Market for Government of Canada Benchmark Bonds

This study examines the impact of increased transparency, brought about by the introduction of three electronic trading systems, on the brokered interdealer market for Government of Canada benchmark securities. Using the CanPX dataset for the 2-, 5-, 10-, and 30-year benchmarks, the paper finds some evidence of decreased bid-ask spreads for the 30-year benchmark in the months following the introduction of the electronic platforms. Bid-ask spreads are not significantly different in the pre- and post-transparency periods for the 2-, 5- or 10-year benchmarks. The price-impact coefficient, calculated using dollar value as a measure of order flow, also decreased in the post-event period for the 30-year benchmark but is not statistically different for any of the other benchmarks. Overall, there is little evidence that liquidity improved or was lowered by the introduction of the electronic systems.Financial markets; Market structure and pricing

The Invisible Power of MacHines Revisiting the Proposed Flash Order Ban in the Wake of the Flash Crash

Technological innovation continues to make trading and markets more efficient, generally benefitting market participants and the investing public. But flash trading, a practice that evolved from high-frequency trading, benefits only a select few sophisticated traders and institutions with the resources necessary to view and respond to flashed orders. This practice undermines the basic principles of fairness and transparency in securities regulation, exacerbates information asymmetries and harms investor confidence. This iBrief revisits the Securities and Exchange Commission\u27s proposed ban on the controversial practice of flash trading and urges the Securities and Exchange Commission and the Commodity Futures Trading Commission to implement the ban across the securities and futures markets. Banning flash trading will not impact high-frequency trading or other advantageous innovative trading practices, and will benefit all market participants by making prices and liquidity more transparent. In the wake of the May 6, 2010 flash crash and the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, now is an opportune time for the Securities and Exchange Commission and Commodity Futures Trading Commission to implement the ban

The Invisible Power of MacHines Revisiting the Proposed Flash Order Ban in the Wake of the Flash Crash

Technological innovation continues to make trading and markets more efficient, generally benefitting market participants and the investing public. But flash trading, a practice that evolved from high-frequency trading, benefits only a select few sophisticated traders and institutions with the resources necessary to view and respond to flashed orders. This practice undermines the basic principles of fairness and transparency in securities regulation, exacerbates information asymmetries and harms investor confidence. This iBrief revisits the Securities and Exchange Commission\u27s proposed ban on the controversial practice of flash trading and urges the Securities and Exchange Commission and the Commodity Futures Trading Commission to implement the ban across the securities and futures markets. Banning flash trading will not impact high-frequency trading or other advantageous innovative trading practices, and will benefit all market participants by making prices and liquidity more transparent. In the wake of the May 6, 2010 flash crash and the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, now is an opportune time for the Securities and Exchange Commission and Commodity Futures Trading Commission to implement the ban

The impact of macroeconomic news on quote adjustments, noise, and informational volatility

We study the impact of the arrival of macroeconomic news on the informational and noise-driven components in high-frequency quote processes and their conditional variances. Bid and ask returns are decomposed into a common ('efficient return') factor and two market-side-specific components capturing market microstructure effects. The corresponding variance components reflect information-driven and noise-induced volatilities.We find that all volatility components reveal distinct dynamics and are positively influenced by news. The proportion of noise-induced variances is highest before announcements and significantly declines thereafter. Moreover, news-affected responses in all volatility components are influenced by order flow imbalances. --effcient return,macroeconomic announcements,microstructure noise,informational volatility

The microstructure approach to exchange rates: a survey from a central bank’s viewpoint

The application of the market microstructure theory to foreign exchange markets in the last few years has introduced a new approach to the analysis of exchange rates. The most important variable of the microstructure analysis, the so-called order flow has proven to be suitable for explaining a significant part of exchange rate changes, not only for high frequency data, but also at longer time horizons that are relevant for macro-economic analysis. Microstructure theory is thus extremely successful from an empirical point of view, especially when compared to traditional exchange rate models. The aim of our study is to provide an introduction to the microstructure-based analysis of exchange rates, emphasising those aspects which may be the most relevant for central banks. In addition to an introduction to the theoretical background of the microstructure approach and the presentation of the key empirical results, we also intend to cast light upon the questions which are important for central banks and which can be tackled successfully using this framework. On the basis of the literature's findings, we present the answers given by the microstructure approach to, among others, questions concerning the efficiency of central bank intervention, the effects of economic news on exchange rates, and the role of different currency market participants in exchange rate developments.exchange rate, order flow, microstructure.