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Market Microstructure and Design

Paper Session

Saturday, Jan. 6, 2018 8:00 AM - 10:00 AM

Loews Philadelphia, Regency Ballroom C1
Hosted By: American Finance Association
  • Chair: Haoxiang Zhu, Massachusetts Institute of Technology

Customer Liquidity Provision: Implications for Corporate Bond Transaction Costs

Jaewon Choi
,
University of Illinois-Urbana-Champaign
Yesol Huh
,
Federal Reserve Board

Abstract

The convention in calculating trading costs in corporate bond markets is to assume that dealers provide liquidity to non-dealers (customers) and to calculate average bid-ask spreads that customers pay dealers. We show that customers often provide liquidity in corporate bond markets, and thus, average bid-ask spreads underestimate trading costs that customers demanding liquidity pay. Since the periods before the 2008 financial crisis, substantial amounts of liquidity provision have moved from the dealer sector to the non-dealer sector, consistent with decreased dealer risk capacity. Among trades where customers are demanding liquidity, we find that these customers pay 35 to 50 percent higher spreads than before the crisis. Our results indicate that liquidity decreased in corporate bond markets and can help explain why, despite the decrease in dealers' risk capacity, average bid-ask spread estimates remain low.

The Ambivalent Role of High-Frequency Trading in Turbulent Market Periods

Nikolaus Hautsch
,
University of Vienna
Michael Noé
,
Humboldt University of Berlin
S. Sarah Zhang
,
University of Manchester

Abstract

We show an ambivalent role of high-frequency traders (HFTs) in the Eurex Bund Futures market around high-impact macroeconomic announcements and extreme events. Around macroeconomic announcements, HFTs serve as market makers, post competitive spreads, and earn most of their profits through liquidity supply. Right before an announcement, however, HFTs significantly widen spreads and cause a rapid but short-lived dry-up of liquidity. In turbulent periods, such as after the U.K. Brexit announcement, HFTs shift their focus from market making activities to aggressive (but not necessarily profitable) directional strategies. Then, HFT activity becomes dominant and market quality can degrade.

Inverted Fee Venues and Market Quality

Carole Comerton-Forde
,
University of Melbourne
Vincent Gregoire
,
University of Melbourne
Zhuo Zhong
,
University of Melbourne

Abstract

Stock exchanges incentivize the demand and supply of liquidity through their fee models. A traditional model pays a rebate to the liquidity supplier and an inverted model pays a rebate to liquidity demanders. We examine the impact of inverted fee models on market quality using an exogenous shock to inverted venue market share created by a regulatory intervention – the 2016 Tick Size Pilot. We show higher inverted venue share improves pricing e ciency and decreases volatility. Our findings suggest that the finer pricing grid provided by inverted venues encourages competition between liquidity providers and improves market quality.
Discussant(s)
Lawrence Harris
,
University of Southern California
Joel Hasbrouck
,
New York University
Mao Ye
,
University of Illinois-Urbana-Champaign
JEL Classifications
  • G1 - General Financial Markets