Overview of Papers Discussed

1
(No Transcript)
2
Overview of Papers Discussed

• Bruce Mizrach and Chris Neely (2006), The
  Microstructure of Bond Market Tatonnement, St.
  Louis Federal Reserve Working Paper 2005-70a.

Bruce Mizrach and Chris Neely (2006), The
Transition to ECNs In the Secondary Treasury
Market. Federal Reserve Bank Review, Nov/Dec.,
forthcoming.
Oleg Korenok, Bruce Mizrach, and Stan Radchenko
(2006), Structural Estimation of Information
Shares.
Michael Fleming, Bruce Mizrach, and Chris Neely
(2006) The On-The Run U.S. Treasury Market A
Complete Snapshot.
3
Outline

• Conceptual Material on Market Microstructure
• Structural Model
• Description of Treasury Market Data and
  Architecture
• Estimates of Treasury Market Information
• Alternative Bayesian Structural Approach
• Conclusion

4
I. Market Microstructure Concepts
5
Market Microstructure

• Hasbrouck Market microstructure is the study of
  trading mechanisms used for financial
  securities.
• The growing availability of transactions
  databases has facilitated the study of high
  frequency phenomena in various markets.
  (Equities TAQ NASTRAQ. FX Olsen)
• The majority of research has been on equities and
  foreign exchange, much less on fixed income.

6
Market Fragmentation

• Similar or identical securities often trade in
  multiple venues.

Hasbrouck In all security markets there is a
trade-off between consolidation and
fragmentation. Consolidation brings all trading
interest together in one place, thereby lessening
the need for intermediaries, but as a regulatory
principle it favors the establishment and
perpetuation of a single market venue with
consequent concern for monopoly power. Allowing
new market entrantsmaximizes competition among
trading venues, but at any given time the trading
interest in a security is likely to be dispersed
(fragmented) among the venues, leading to
increased intermediation and price discrepancies
among markets. (Italics added).
This paper IDB spot versus futures markets in
Treasuries. Mizrach and Neely (2006) IDB voice
markets versus electronic markets
Treasuries. Korenok, Mizrach and Radchenko
(2006) 6 stocks that have dual listings on NYSE
and Nasdaq. Fleming, Mizrach and Neely BrokerTec
versus eSpeed ECNs.
7
Market Architecture

• Securities also trade in a hybrid environment of
  market designs or architectures.
• NYSE Floor based auction organized by a
  specialist
• Nasdaq Interdealer electronic network
• ECNs (ATS) Electronic networks with no dealer
  intermediaries (e.g. Archipelago, Instinet for
• equities, BrokerTec, eSpeed for U.S. Treasuries)
• Open outcry CME, CBOT futures pits, Treasury
  phone based market
• This is a rich area for empirical industrial
  organization research.

8
Fundamental Concepts - Liquidity

• Hasbrouck Liquidity is a summary quality or
  attribute of a security or asset market.

• Spreads Difference between buyer and seller
  initiated prices.

• Depth The quantity available for sale or
  purchase away from the current market price.

• Breadth The market has many participants.

• Resilience Price impacts caused by the trading
  are small and quickly die out.

9
Fundamental Concepts Price Discovery

• Madhavan (2002, FAJ) Price discovery is the
  process by which prices incorporate new
  information.
• In the papers discussed today, we focus on the
  dimension of which market leads other markets in
  the price discovery process. This concept is
  called information share. This paper is the first
  to compare spot and derivatives markets in
  Treasuries.
• Hasbrouck (1995) The information share
  associated with a particular market is defined as
  the proportional contribution of that market's
  innovations to the innovation in the common
  efficient price. Lehmann (2002) a
  decomposition of the variance of innovations to
  the long run price.

Enough chatting, lets get to the model!!
10
II. Hasbrouck Model
11
Multimarket Security Model - Hasbrouck (1995)
The price in security market i differs from the
fundamental price p only transiently. The
coefficient ß is there because futures and cash
markets may have a slightly different basis.
The fundamental price itself follows a random
walk. Error terms ? and ? can be
contemporaneously and serially correlated.
This is called an unobserved components model
because we dont observe the efficient price
directly.
12
Permanent Component
If we assume the individual prices are I(1), have
a VAR(r) representation, and that markets are
cointegrated, the price vector has the
Engle-Granger error correction form
Note daily coefficient to adjust for futures
basis and/or cheapest to deliver.
Matrix of long run multipliers
Note that this approach uses the reduced form VAR
rather than the structural model (as in Korenok,
Mizrach and Radchenko (2006)).
13
Effect of Shocks In the Long Run
In computing the long-run effects of a shock, we
need to take into account contemporaneous
correlation
by taking a Choleski decomposition, finding
Now, of course, we have all the same problems
that the macroeconomists do. The Choleski
decomposition is not unique. (1) This paper
reports upper bound estimates (2) An argument in
favor of working directly with the structural
model.
14
Information Shares
Hasbrouck
Gonzalo-Granger (Harris, McInish and Wood (2002))
Other estimates include deJong and Schotman
(2004), Yan and Zivot (2005). Lehmann (2002)
attempts to reconcile these.
15
III. Description of Treasury Market Data and
Architecture
16
U.S. Treasury Market
This paper focuses on IDB voice transactions in
GovPX, and futures market transactions from the
CME and CBOT,
Cantors eSpeed is discussed in Mizrach and Neely
(2006). BrokerTec and eSpeed are discussed in
Fleming, Mizrach and Neely (2006).
17
On-The Run Treasury Market in 2005
Mizrach/Neely (2006) On-the-run volume nearly
100 electronic, split between eSpeed and
BrokerTec, two ECNs.
Momentum is with BrokerTec. Cantor had 70 share
in 2001.
18
Mizrach/Neely (2005) - Sample
Spot Market
2-year, 5-year and 10-year on the run Treasuries,
October 1, 1995 to March 31, 2001, from GovPX.
Open outcry trades from 3 major firms
Garban-Intercapital Hilliard Farber and Tullett
Liberty.
A voice market with screen based display of
quotes. This is NOT an ECN. Trading is by large
institutions. gt 1mn per trade Traders have a
workup facility. Boni and Leach (2002).
Futures Market
3-month Eurodollar, 10-year and 30-year Treasury
futures. The bonds trade on the CBOT, the
Eurodollar on the CME.
We use the hours that the futures markets are
open 820 to 1500 CST.
19
Trading Activity Spot Markets
20
Trading Activity on ECNs
Notes The data are daily averages for the period
October 12 - December 31, 2004.
Mizrach and Neely (2006) show a 635 growth in
the 2-year and a 2000 increase in the 5-year
just on the eSpeed platform. The Treasury market
has joined the equity and foreign exchange
markets in attracting computerized trading. More
than 50 of BrokerTec quotes are from
computerized trades (Safarik, 2005) rather than
from the primary dealers.
21
Trading Activity Futures Markets
22
Liquidity IDB Spot Market
Depth and spreads Fleming (EPR, 2003). Sample
period 1997-2000. Market impact Mizrach and
Neely (2006) for January 1999.
23
ECN Liquidity
Spreads and market impact have fallen by 75.
24
IV. Information Shares
25
Comparison of Information Shares
26
Summary of Information Share Results
These are upper bound estimates (placing spot
market first in orthogonalization) of bimarket
comparisons between spot and the closest maturity
future.
The spot markets all have information shares
below 50 by 2001, with the decline really
accelerating after 1999. Futures vital to price
discovery process.
H and GG measures have very similar qualitative
results.
27
Information Share in ECNs
BrokerTec 10-year information share. BTec gt 50
except for 30-year.
28
What Explains Information Share
We model IS share as a function of
Where N1 is the number of trades in market 1, S1
is the percentage spread in market 1, and Di is a
dummy variable for 8 different sets of
macroeconomic announcements.
Trades and spreads explain 10-15 of the
differences in information shares. (Not bad for
microstructure studies).
Macroeconomic announcements are rarely
significant. Only the employment report (on 2
occasions) is significant.
29
Full System Estimation
The GG story is a little cleaner by 2001, the
10-year and 30-year futures have the dominant
information shares.
30
V. Bayesian Structural Estimation
31
State Space Representation
For the HUC model
We are interested in estimation of the structural
parameters a, s², O. Parameters are estimated by
MCMC, drawing the variance-covariance matrix of
vt and computing a, s² and O using this matrix.
We also obtain confidence measures on these
estimates from the Markov chain Monte Carlo
iterations. These are much less ad hoc than
sample averages of daily estimates and/or the
upper lower bound estimates from the Hasbrouck
orthogonalization.
32
Information Shares Mapping From Structural Model
Structural autocovariances
Reduced form
Moments matched
Solution
IS derived from these
33
Information Shares
All of the information share measures in the
literature (1) Hasbrouck (H) (2)
Gonzalo-Granger (GG) (3) deJong and Schotman
(DS) (4) Yan and Zivot (YZ) can be redefined in
terms of parameters of the structural model.
We also obtain confidence measures on these
estimates from the Markov chain Monte Carlo
iterations. These are much less ad hoc than
sample averages of daily estimates and/or the
upper lower bound estimates from the Hasbrouck
orthogonalization.
Caveats (1) GG Information shares can be
negative. (2) Hasbrouck shares are positive by
construction, but can give the largest IS to a
market which moves prices away from the efficient
price.
34
Conclusion
Information shares are a useful summary statistic
of the relative importance of market structures
that are fragmented.
Despite strong identification assumptions, these
measures correlate well with observable liquidity.
Treasury market Ignore the futures at your
peril. ECNs and black boxes makes this market
potentially more volatile. Supply constraints
(reopenings, off-the-run, close substitutes like
corporates) make these concerns second order in
my view.
Direct estimation of the structural model seems
to be the best way to go forward in this
literature.