Price discovery in spot and futures markets: a reconsideration

We reconsider the issue of price discovery in spot and futures markets. We use a threshold error correction model to allow for arbitrage operations to have an impact on the return dynamics. We estimate the model using quote midpoints, and we modify the model to account for time-varying transaction costs. We find that the futures market leads in the process of price discovery. The lead of the futures market is more pronounced in the presence of arbitrage signals. Thus, when the deviation between the spot and the futures market is large, the spot market tends to adjust to the futures market

Organized equity markets in Germany

The German financial system is the archetype of a bank-dominated system. This implies that organized equity markets are, in some sense, underdeveloped. The purpose of this paper is, first, to describe the German equity markets and, second, to analyze whether it is underdeveloped in any meaningful sense. In the descriptive part we provide a detailed account of the microstructure of the German equity markets, putting special emphasis on recent developments. When comparing the German market with its peers, we find that it is indeed underdeveloped with respect to market capitalization. In terms of liquidity, on the other hand, the German equity market is not generally underdeveloped. It does, however, lack a liquid market for block trading. Klassifikation: G 51 . Revised version forthcoming in "The German Financial System", edited by Jan P. Krahnen and Reinhard H. Schmidt, Oxford University Press

Price Discovery in Floor and Screen Trading Systems

We analyze price discovery in floor-based and electronic exchanges using data from the German stock market. We find that both markets contribute to price discovery. There is bidirectional Granger causality, and prices from both markets adjust to deviations from the long-run equilibrium. We use two different measures of the contributions to price discovery, the information share (Hasbrouck 1995) and the weights with which the series enter the common long memory component as defined by Gonzalo / Granger (1995). The contributions of the two trading systems to the process of price discovery are almost equal when transaction prices are used for the estimation. Models based on quote midpoints indicate that the electronic trading system has a larger share in the price discovery process. A cross-sectional analysis reveals that the contributions to price discovery are positively related to the market shares of the trading systems.Floor versus screen trading, Error correction, Information shares, Common long memory components

Organized Equity Markets in Germany

The German financial system is the archetype of a bank-dominated system. This implies that organized equity markets are, in some sense, underdeveloped. The purpose of this paper is, first, to describe the German equity markets and, second, to analyze whether it is underdeveloped in any meaningful sense. In the descriptive part we provide a detailed account of the microstructure of the German equity markets, putting special emphasis on recent developments. When comparing the German market with its peers, we find that it is indeed underdeveloped with respect to market capitalization. In terms of liquidity, on the other hand, the German equity market is not generally underdeveloped. It does, however, lack a liquid market for block trading.Market size, liquidity, floor versus screen trading

Floor versus Screen Trading : Evidence from the German Stock Market

The last decade has witnessed a dramatic increase in both the number and the market share of screen-based trading systems. Electronic trading systems do offer lower operating costs and the possiblilty of remote access to the market. On the other hand, arguments based on the anonymity of electronic trading systems suggest that adverse selection may be a more severe problem and that, therefore, bid-ask spreads may be higher. The present paper addresses the issue of transaction costs in floor and computerized trading systems empirically. In Germany, floor and screen trading for the same stocks exist in parallel. Both markets are liquid and operate simultaneously for several hours each day. An analysis of the bid-ask spreads reveals that the electronic trading system is relatively less attractive for less liquid stocks. The market shares of the competing systems reveal a similar pattern. The market share of the electronic trading system is negatively related to the total trading volume of the stock, is positively related to the difference between spreads on the floor and in the screen trading system and is at least partially negatively related to return volatility. We further document that spreads in the electronic trading system respond more heavily to changes in return volatility and that the adverse selection component of the spread is larger. We discuss implications our results have for the design of electronic trading systems.Electronic trading systems; anonymity; bid-ask spreads; adverse selection costs

Short sale constraints, divergence of opinion and asset values: evidence from the laboratory

The overvaluation hypothesis (Miller 1977) predicts that a) stocks are overvalued in the presence of short selling restrictions and that b) the overvaluation increases in the degree of divergence of opinion. We design an experiment that allows us to test these predictions in the laboratory. The results indicate that prices are higher with short selling constraints, but the overvaluation does not increase in the degree of divergence of opinion. We further find that trading volume is lower and bid-ask spreads are higher when short sale restrictions are imposed. JEL Classification: C92, G14 Keywords: Overvaluation Hypothesis , Short Selling Constraints , Divergence of Opinio

A partially linear approach to modelling the dynamics of spot and futures prices

In this paper we consider the dynamics of spot and futures prices in the presence of arbitrage. We propose a partially linear error correction model where the adjustment coefficient is allowed to depend non-linearly on the lagged price difference. We estimate our model using data on the DAX index and the DAX futures contract. We find that the adjustment is indeed nonlinear. The linear alternative is rejected. The speed of price adjustment is increasing almost monotonically with the magnitude of the price difference

Sooner or later: delays in trade reporting by corporate insiders

Until October 2004 corporate insiders in Germany were required to report trades in the shares of their firm 'without delay'. In practice substantial reporting delays were common. We show that the delays are systematically related to the characteristics of the firm. Delays are longer in widely-held firms and in firms using German accounting standards. This suggests that managers of these firms are less responsive to the informational requirements of the capital market. We further find that abnormal returns after the reporting date of an insider trade are independent of the reporting delay. This implies that prices are distorted in the period between the trading and the reporting date. This is a strong point in favor of regulation requiring and enforcing immediate disclosure of insider trades. --insider trading,directors' dealings,accounting standards

Competition between exchanges : Euronext versus Xetra

Exchanges in Europe are in a process of consolidation. After the failure of the proposed merger between Deutsche Börse and Euronext, these two groups are likely to become the nuclei for further mergers and co-operation with currently independent exchanges. A decision for one of the groups entails a decision for the respective trading platform. Against that background we evaluate the attractiveness of the two dominant continental European trading systems. Though both are anonymous electronic limit order books, there are important differences in the trading protocols. We use a matched-sample approach to compare execution costs in Euronext Paris and Xetra. We find that both quoted and effective spreads are lower in Xetra. When decomposing the spread we find no systematic differences in the adverse selection component. Realized spreads, on the other hand, are significantly higher in Euronext. Neither differences in the number of liquidity provision agreements nor differences in the minimum tick size or in the degree of domestic competition for order flow explain the different spread levels. We thus conclude that Xetra is the more efficient trading system. JEL Classification: G10, G1

Short sale constraints, divergence of opinion and asset value: Evidence from the laboratory

The overvaluation hypothesis (Miller 1977) predicts that a) stocks are overvalued in the presence of short selling restrictions and that b) the overvaluation increases in the degree of divergence of opinion. We design an experiment that allows us to test these predictions in the laboratory. The results indicate that prices are higher with short selling constraints, but the overvaluation does not increase in the degree of divergence of opinion. We further find that trading volume is lower and bid-ask spreads are higher when short sale restrictions are imposed. --overvaluation hypothesis,short selling constraints,divergence of opinion