We study market microstructure noise in high-frequency data and analyze its implications for the realized variance (RV) under a general specification for the noise. We show that kernel-based estimators can unearth important characteristics of market microstructure noise and that a simple kernel-based estimator dominates the RV for the estimation of integrated variance (IV). An empirical analysis of the Dow Jones Industrial Average stocks reveals that market microstructure noise is time-dependent and correlated with increments in the efficient price. This has important implications for volatility estimation based on high-frequency data. Finally, we apply cointegration techniques to decompose transaction prices and bid–ask quotes into an estimate of the efficient price and noise. This framework enables us to study the dynamic effects on transaction prices and quotes caused by changes in the efficient price.

/pdf/realized-variance-and-market-microstructure-noise-2l8x1pctf2.pdf

Realized Variance and Market Microstructure Noise

We study market microstructure noise in high-frequency data and analyze its implications for the realized variance (RV) under a general specification for the noise. We show that kernel-based estimators can unearth important characteristics of marketmicrostructure noise and that a simple kernel-based estimator dominates the RV for the estimation of integrated variance (IV). An empirical analysis of the Dow Jones Industrial Average stocks reveals that market microstructure noise is time-dependent and correlated with increments in the efficient price. This has important implications for volatility estimation based on high-frequency data. Finally, we apply cointegration techniques to decompose transaction prices and bid-ask quotes into an estimate of the efficient price and noise. This framework enables us to study the dynamic effects on transaction prices and quotes caused by changes in the efficient price.

/pdf/realized-variance-and-market-microstructure-noise-3dbmd7mnzx.pdf

We analyse the behaviour of credit default swaps (CDS) for a sample of firms and find support for the theoretical equivalence of CDS prices and credit spreads. When this is violated we suggest the CDS price can be viewed as an upper bound on the price of credit risk, while the spread provides a lower bound. We show that the CDS market is the main forum for credit risk price discovery and that CDS prices are better integrated with firm-specific variables in the short-run. Both markets equally reflect these factors in the long-run, and this is primarily brought about by bond market adjustment.

/pdf/an-empirical-analysis-of-the-dynamic-relationship-between-ooaphvwv1u.pdf

An empirical analysis of the dynamic relationship between investment-grade bonds and credit default swaps

We test the theoretical equivalence of credit default swap (CDS) prices and credit spreads derived by Duffie (1999), finding support for the parity relation as an equilibrium condition. We also find two forms of deviation from parity. First, for three firms, CDS prices are substantially higher than credit spreads for long periods of time, arising from combinations of imperfections in the contract specification of CDSs and measurement errors in computing the credit spread. Second, we find short-lived deviations from parity for all other companies due to a lead for CDS prices over credit spreads in the price discovery process. RISKY CORPORATE AND SOVEREIGN BONDS are among the most recent securities to

https://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/04/Fic/dt0401e.pdf

An Empirical Analysis of the Dynamic Relation between Investment-Grade Bonds and Credit Default Swaps

We investigate the contribution of option markets to price discovery, using a modification of Hasbrouck’s (1995) “information share” approach. Based on five years of stock and options data for 60 firms, we estimate the option market’s contribution to price discovery to be about 17% on average. Option market price discovery is related to trading volume and spreads in both markets, and stock volatility. Price discovery across option strike prices is related to leverage, trading volume, and spreads. Our results are consistent with theoretical arguments that informed investors trade in both stock and option markets, suggesting an important informational role for options. INVESTORS WHO HAVE ACCESS to private information can choose to trade in the stock market or in the options market. Given the high leverage achievable with options and the built-in downside protection, one might think the options market would be an ideal venue for informed trading. If informed traders do trade in the options market, we would expect to see price discovery in the options market. That is, we would expect at least some new information about the stock price to be reflected in option prices first. Establishing that price discovery straddles both the stock and options markets is important for several reasons. In a frictionless, dynamically complete market, options would be redundant securities. This paper contributes to the understanding of why options are relevant in actual markets, by providing the first unambiguous evidence that stock option trading contributes to price discovery in the underlying stock market. Further, we document that the level

/pdf/informed-trading-in-stock-and-option-markets-3w9iuubmvi.pdf

Informed Trading in Stock and Option Markets

Price discovery and common factor models

On May 10, 1999, the London International Financial Futures and Options Exchange (LIFFE) transferred trading in the Financial Times Stock Exchange (FTSE) 100 Index futures contracts from outcry to LIFFE CONNECT, its electronic trading system. We find lower spreads in the electronic market after the transition. However, the open outcry mechanism has higher market quality (or smaller variance of the pricing error) on the basis of Hasbrouck's (1993) model. Furthermore, employing the Hasbrouck (1991) model, we show that trades in the open outcry market have higher information content. Inventory control considerations also affect the electronic market more than the open outcry market. The overall results suggest that electronic trading should complement, but not replace, open outcry in futures markets. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21: 713–735, 2001

Transaction Costs and Market Quality: Open Outcry Versus Electronic Trading

On the Chicago Mercantile Exchange (CME) so-called "E-mini" index futures contracts trade on the electronic GLOBEX trading system alongside the corresponding full-size contracts that trade on the open outcry floor. This paper finds that the current minimum tick sizes of the E-mini S&P 500 and E-mini Nasdaq-100 futures contracts act as binding constraints on the bid-ask spreads by not allowing the spreads to decline to competitive levels. We also find that, while exchange locals trade very actively on GLOBEX, they do not tend to act as liquidity suppliers. Taken together, our empirical results suggest that it is time for the CME to consider decreasing the minimum tick sizes of the S&P 500 and Nasdaq-100 E-mini futures contracts. A tick size reduction is likely to result in lower trading costs in the E-mini futures markets.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID483162_code341869.pdf?abstractid=483162&mirid=1

Is it Time to Reduce the Minimum Tick Sizes of the E-mini Futures?

On February 1, 2002, the Chicago Board of Trade appointed a designated market maker to enhance liquidity in its 10-year interest rate swap futures contract. This market-making program is the first of its kind in the open-outcry futures industry. We find that introduction of the market maker has increased volume and reduced transaction costs. The market maker has also enhanced the speed and the efficiency of price discovery. Overall, the results suggest that the market-making program is successful in improving liquidity. © 2004 Wiley Periodicals, Inc. Jrl Fut Mark 24:479–502, 2004

Do designated market makers improve liquidity in open-outcry futures markets?

On the Chicago Mercantile Exchange (CME), so-called “E-mini” index futures contracts trade on the electronic GLOBEX trading system alongside the corresponding full-size contracts that trade on the open outcry floor. This paper finds that the current minimum tick sizes of the E-mini S&P 500 and E-mini Nasdaq-100 futures contracts act as binding constraints on the bid-ask spreads by not allowing the spreads to decline to competitive levels. We also find that, while exchange locals trade very actively on GLOBEX, they do not tend to act as liquidity suppliers. Taken together, our empirical results suggest that it is time for the CME to consider decreasing the minimum tick sizes of the S&P 500 and Nasdaq-100 E-mini futures contracts. A tick size reduction is likely to result in lower trading costs in the E-mini futures markets. © 2005 Wiley Periodicals, Inc. Jrl Fut Mark 25:79–104, 2005

Tatyana Zabotina

Papers

Price discovery and common factor models

Transaction Costs and Market Quality: Open Outcry Versus Electronic Trading

Is it Time to Reduce the Minimum Tick Sizes of the E-mini Futures?

Do designated market makers improve liquidity in open-outcry futures markets?

Is it time to reduce the minimum tick sizes of the E‐mini futures?