Price Pressures by Terence Hendeshott and Albert J Menkveld

1
Price Pressuresby Terence Hendeshott and
Albert J Menkveld

• Discussant
• Jeremy Large, AHL and Oxford-Man Institute at
  Oxford University
• 1 May 2009

2
Overview

• Price pressures price deviations from
  fundamentals when
• A risk-averse intermediary supplies liquidity
• Asynchronously arriving investors have differing
  trading requirements
• Theoretical model illustrates the inefficiencies
  of price pressures
• They are caused by the intermediarys response to
  bearing inventory risk
• They cause investors not to complete valuable
  trades
• Throughout paper, focus is on (2) lowering of
  realized hedge values
• Numerical analysis of theoretical model,
  following Ho and Stoll (1981)
• shows that illiquidity exacerbates the lowering
  of realized hedge values
• Econometric model quantifies the effect(s)
• Structural state-space model with unique dataset
  of daily overnight positions of NYSE specialists,
  94 05 (also ssfpack for ox)

3
Theoretical model

• Lowering of realized hedge values
• Price pressures cause inefficiency because they
  present distorted prices to investors, which
  preclude some investors from completing valuable
  trades
• A theoretical model quantifies this inefficiency,
  finding it to be the product of
• the variance of specialists inventories (in
  dollars)
• one minus the (1st order) autocorrelation of
  inventory
• (this quantifies the effect on signed order flow
  of the price pressure)
• sensitivity of prices to specialists inventories
• This is the case under parametric structural
  assumptions.

4
Empirical model

• Empirical section uses a unique dataset
  consisting of daily reported NYSE specialist
  positions, and a state space model (ssfpack for
  ox) to quantify
• transitory volatility and show it is larger for
  small stocks
• the effect on the price of shocks to the
  specialists position
• the dollar value of the lowering of realized
  hedge values
• (median 4m / stock / yr)
• Model for a single market
• Underlying price, mt, is a random walk
• mt mt-1 (ß?t wt)
•  
• Observed price, pt, deviates from underlying
  price by a Price Pressure of st
• pt mt st
•  
• Price Pressure term depends on specialists
  inventory and lagged terms, plus an innovation et.

5
Main Comments

• Method should let you quantify the total realized
  gains from trade in the market?! (Total hedge
  value rate)
• A benefit to more specification testing? (e.g.
  are the inventory residuals autocorrelated?)
•  
• Other researchers call st market microstructure
  noise, caused by e.g. price discreteness. Do you
  / can we disentangle this from price pressure?
•   
• Remark that specialists are of declining
  importance

6
Secondary Comments

• Are you the first to identify how price pressures
  can lower realized hedge values?
•  
• Purging systemic movements from the econometric
  analysis introduces complications such as
  lagged-gammas in one equation.
• Would be simpler, hence informative/complementary
  also to present results with systemic returns in?
• Could we have an explicit time-line over the day,
  of inventory samples, price samples? Could
  inventories be lagging rather than leading price
  pressures?