Stalking the "Efficient Price" in Market Microstructure Specifications: An Overview

The principle that revisions to the expectation of a security's value should be unforecastable identifies this expectation as a martingale. When price changes can plausibly be assumed covariance stationary, this in turn motivates interest in the random walk. In the presence of the market frictions featured in many microstructure models, however, this expectation does not invariably coincide with observed security prices such as trades and quotes. Accordingly, the random walk becomes an implicit, unobserved component. This paper is an overview of econometric approaches to characterizing this important component in single- and multiple-price applications

Securities trading in the absence of dealers: Trades and quotes on the Tokyo Stock Exchange

This paper investigates the behavior of intraday trades and quotes for individual stocks on the Tokyo Stock Exchange (TSE). The TSE has no designated market makers and is further distinguished by daily and intraday price limits and conversion to limit orders of market order portions that exceed the size of the current quote. We examine the transaction and quote record for three firms for the first three months of 1990. Our findings suggest that the immediacy available (at least for small trades) in the market is high, despite the reliance on public limit orders to supply liquidity. When orders that would otherwise walk through the limit order book are converted into limit orders, execution is delayed, but some orders execute (at least in part) at more favorable prices. Holding order size constant, orders that are delayed in this fashion appear to have a larger information content. Finally, as a consequence of limit order cancellation and autocorrelation in arriving orders, the bid (offer) quote tends to deteriorate further after a sale (purchase)

Securities trading in the absence of dealers: Trades and quotes on the Tokyo Stock Exchange

This paper investigates the behavior of intraday trades and quotes for individual stocks on the Tokyo Stock Exchange (TSE). The TSE has two distinctive institutional features: (1) the absence of market makers who trade for their own accounts, and (2) use of price limits. Our findings suggest that the immediacy available in the market is high, despite the reliance on public limit orders to supply liquidity. The price limit mechanism causes some trades to execute more slowly, but allows many incoming market orders to transact at more favorable prices. We furthermore examine the impact of trades on quotes. The TSE's mechanism is similar in many respects to the electronic limit order book modeled by Glosten (1991). Consistent with Glosten's prediction, we find some evidence for quote reversals subsequent to trades

Common Factors in Prices, Order Flows and Liquidity

How important are cross-stock common factors in the price discovery/liquidity provision process in equity markets? We investigate two aspects of this question for the thirty Dow stocks. First, using principal components and canonical correlation analyses we find that both returns and order flows are characterized by common factors. Commonality in the order flows explains roughly half of the commonality in returns. Second, we examine variation and common covariation in various liquidity proxies and market depth (trade impact) coefficients. Liquidity proxies such as the bid-ask spread and bid-ask quote sizes exhibit time variation which helps explain time variation in trade impacts. The common factors in these liquidity proxies are relatively small, however

Intraday Price Formation in US Equity Index Markets

The market for US equity indexes has traditionally comprised floor-traded index futures contracts and the individual markets for the component stocks. This picture has been altered by the advent of exchange-traded funds (ETFs) that mirror the indexes, electronically-traded, small-denomination (“E-mini”) futures contracts, and (for the S&P 500) a family of sector ETFs that break the index into nine components. This paper empirically investigates price discovery (price leadership) in this new environment. The specifications are estimated at very fine (up to one second) time resolution. The principal findings are as follows

The Dynamics of Discrete Bid and Ask Quotes

This paper describes a general approach to the estimation of security price dynamics when the phenomena of interest are of the same scale or smaller than the tick size. The model views discrete bid and ask quotes as arising from three continuous random variables: the efficient price of the security, a cost of quote exposure (information and processing costs) on the bid side and a similar cost of quote exposure on the ask side. The bid quote is the efficient price less the bid cost rounded down to the next tick; the ask quote is the efficient price plus the ask cost rounded up to the next tick. To deal with situations in which the cost of quote exposure both stochastic and deterministic components and the increments of the efficient price are nonstationary, the paper employs a nonlinear state-space estimation method. The method is applied to intraday quotes at fifteen-minute intervals for Alcoa (a randomly chosen Dow stock). The results confirm the existence of persistent intraday volatility. More importantly they establish the existence of a persistent stochastic component of quote exposure costs that is large relative to the deterministic intraday “U” component

Security Bid/Ask Dynamics with Discreteness and Clustering: Simple Strategies for Modeling and Estimation

This paper proposes a dynamic model of bid and ask quotes that incorporates a stochastic cost of market-making, discreteness (restriction of quotes to a fixed grid) and clustering (the tendency of quotes to lie on “natural” multiples of the tick size). The Gibbs sampler provides a convenient vehicle for estimation. The model is estimated for daily and intradaily US Dollar/Deutschemark Reuters quotes

Stalking the "Efficient Price" in Market Microstructure Specifications: An Overview

The principle that revisions to the expectation of a security's value should be unforecastable identifies this expectation as a martingale. When price changes can plausibly be assumed covariance stationary, this in turn motivates interest in the random walk. In the presence of the market frictions featured in many microstructure models, however, this expectation does not invariably coincide with observed security prices such as trades and quotes. Accordingly, the random walk becomes an implicit, unobserved component. This paper is an overview of econometric approaches to characterizing this important component in single- and multiple-price applications

The Dynamics of Discrete Bid and Ask Quotes

This paper describes a general approach to the estimation of security price dynamics when the phenomena of interest are of the same scale or smaller than the tick size. The model views discrete bid and ask quotes as arising form the three continuous random variables: the efficient price of the security, a cost of quote exposure (information and processing costs) on the bid side and a similar cost of quote exposure on the ask side. The bid quote is the efficient price less the bid cost rounded down to the next tick; the ask quote is the efficient price plus the ask cost rounded up to the next tick. To deal with situations in which the cost of quote exposure possesses both stochastic and deterministic components and the efficient price follows an EGARCH process, the paper employs a nonlinear state-space estimation method. The method is applied to intraday quotes at fifteen-minute intervals for Alcoa (a randomly chosen Dow stock). The results confirm the existence of persistent intraday volatility. More importantly they establish the existence of a persistent stochastic component of quote exposure costs that is large relative to the deterministic intraday 'U' component

Intraday Price Formation in US Equity Index Markets

The market for US equity indexes has traditionally comprised floor-traded index futures contracts and the individual markets for the component stocks. This picture has been altered by the advent of exchange-traded funds (ETFs) that mirror the indexes, electronically-traded, small-denomination (“E-mini”) futures contracts, and (for the S&P 500) a family of sector ETFs that break the index into nine components. This paper empirically investigates price discovery (price leadership) in this new environment. The specifications are estimated at very fine (up to one second) time resolution. The principal findings are as follows