Party Formation and Competition

In the majority of democratic political systems, districts elect representatives, who form coalitions, which determine policies. In this paper we present a model which captures this process: A citizen-candidate model with multiple policy dimensions in which elected representatives endogenously choose to form parties. Numerical analysis shows that in equilibrium this model produces qualitatively realistic outcomes which replicate key features of cross-country empirical data, including variation consistent with Duverger's law. The numbers of policy dimensions and representatives elected per district are shown to determine the number, size, and relative locations of parties. Whilst multi-member district systems are found to reduce welfare.Citizen-Candidate Model; Political Competition; Party Formation; Duverger’s Law; Computer Simulation

Dark trading and alternative execution priority rules

Traders' choice between lit and dark trading venues depends on market conditions, which are affected by execution priority rules in the dark pool, adverse selection, and traders' competition. We show that dark trading activity has a non-linear relationship with asset volatility and liquidity, which explains previous mixed empirical results regarding the impact of dark pools on market quality. The introduction of dark pools increases welfare only for speculators, while other traders (even large traders) are worse off. Importantly, we show that a size execution priority rule improves global welfare and liquidity relative to a time execution priority for dark orders

Heterogeneous beliefs in over-the-counter markets

The behavior and stability of over-the-counter markets is of central concern to regulators. Little is known, however, about how the structure of these markets determine their properties. In this paper we consider an over-the-counter market populated by boundedly rational heterogeneous traders in which the structure is represented by a network. Stability is found to decrease as the market becomes less well connected, however, the configuration of connections has a significant effect. The presence of hubs, such as those found in scale free networks increases stability and decreases volatility whilst small-world short-cut links have the opposite effect. Volatility in the fundamental value increases market volatility, however, volatility in the riskless asset returns has an ambiguous effect

Fragmentation and stability of markets

Trading skills are highly rewarded in practice but largely ignored in theoretical models of financial markets. This paper demonstrates the importance of skills by examining their interaction with market fragmentation and market stability. We consider a computational model where traders’ abilities to accurately price assets are endogenous. In contrast to models that do not consider skills, we find that centralising markets can lead to higher price volatility and less resilience to shocks because it increases the equilibrium proportion of unskilled traders

Market ecologies: The effect of information on the interaction and profitability of technical trading strategies

Technical trading strategies make profits by identifying and exploiting patterns in market prices—patterns generated by the interaction of market participants. Using a model market populated by individuals using a range of trading rules we show that the presence of technical traders may be beneficial, in some cases reducing volatility and increasing price efficiency. In particular, contrarian traders who base their decisions on high frequency data have the largest positive effect. It is also found that if technical traders condition their actions using ‘real time’ information, they partially emulate arbitrageurs and make positive profits

An economic model of contagion in interbank lending markets An economic model of contagion in interbank lending markets

Abstract This paper examines the relationship between the structure of the interbank lending market and systemic risk. We consider a model in which banks finance investment opportunities through household deposits and borrowing from other banks. Using simulation techniques a range of interbank markets structures are considered. It is shown that greater levels of interbank connectivity reduce the risk of contagion from the failure of a single bank. In response to system wide shocks, however, the effect of connectivity is ambiguous, reducing contagion for small shocks but exacerbating it for larger events. Regulatory changes including forcing banks to hold more reserves, be less leveraged or constraining the size of borrowing relations are tested and their effects considered

The High Frequency Trade Off Between Speed and Sophistication

Central to the ability of a high frequency trader to make money is speed. In order to be first to trading opportunities, firms invest in the fastest hardware and the shortest connections between their machines and the markets. Yet this is not enough: algorithms must be short, no more than a few instructions. As a result there is a trade-off in the design of optimal high frequency trading strategies: being the fastest necessitates being less sophisticated. To understand the effect of this tension a computational model is presented that captures latency, both of code execution and information transmission. Trading algorithms are modelled through genetic programming with longer programmes allowing more sophisticated decisions at the cost of slower execution times. It is shown that, depending on the market composition, short fast strategies and slower more sophisticated strategies may both be viable and exploit different trading opportunities. The relative profits of these different approaches vary, however, slow traders benefit and social welfare increase in the presence of HFTs. A suite of regulations are tested to manage the risks associated with high frequency trading, the majority are found to be ineffective, though constraining the ratio of orders to trades may be promising

An economic model of contagion in interbank lending markets

This paper examines the relationship between the structure of the interbank lending market and systemic risk. We consider a model in which banks finance investment opportunities through household deposits and borrowing from other banks. Using simulation techniques a range of interbank markets structures are considered. It is shown that greater levels of interbank connectivity reduce the risk of contagion from the failure of a single bank. In response to system wide shocks, however, the effect of connectivity is ambiguous, reducing contagion for small shocks but exacerbating it for larger events. Regulatory changes including forcing banks to hold more reserves, be less leveraged or constraining the size of borrowing relations are tested and their effects considered

Contagion and risk-sharing on the interbank market

Increasing numbers of inter-bank lending relationships have an ambiguous effect on financial stability. Studies have shown that fewer inter-bank loans limit the spread of bankruptcies whilst other work has argued that greater connectivity aids risk sharing. In this paper we identify the conditions under which each relationship holds. Using numerical techniques we demonstrate that in response to a large economy-wide shock, higher numbers of inter-bank lending relationships worsen the impact of the event, however, for smaller shocks the opposite relationship is observed. As such there is no optimal inter-bank market structure which reduces contagion under all economic conditions

Costs and benefits of speculation

We quantify the effects of financial regulation in an equilibrium model with delegated portfolio management. Fund managers trade stocks and bonds in an order-driven market, subject to transaction taxes and constraints on short-selling and leverage. Results are obtained on the equilibrium properties of portfolio choice, trading activity, market quality and price dynamics under the different regulations. We find that short- sale restrictions reduce short-term volatility and long swings in asset prices, while transaction taxes do more harm than good