Market Depth Research Articles

Quality of Financial Markets: Case Study from Emerging Market Economies

This paper investigates the quality aspect of financial markets in emerging economies and the key variables to achieve a desired level of quality. In our panel analysis, 17 major emerging countries were taken as a sample to analyze the relationship between quality of financial markets and the factors that affect quality. To measure the quality of financial markets, composite indexes were created that reflect the degree of financial market accessibility, depth, and efficiency. Besides, the indexes include the liquidity, diversity, and the institutional environment of financial markets in emerging economies. The variables include financial institutions access, depth, and efficiency on one set and on the other set financial market access, depth, and efficiency. The indexes and sub-indexes were extracted from the database of International Monetary Fund’s International Financial Statistics office that holds global dataset of main indicators. Besides, World Development Indicators (WDI) indexes were employed to the research. We found that quality of financial markets and growth of financial development are highly correlated to each other. The disaggregated components of the quality measure suggest that it is the level of legal and institutional development along with accessibility, depth, and efficiency that affects the overall financial market growth. Hence, financial market quality. Our simple regressions show that the quality measures of financial markets have a positive output on higher quality of financial markets and growth of financial development. The causality of relationships between the components of financial markets and components of financial institutions were proven to have negative correlation showing that countries that pay more attention to the growth of financial institutions usually have less developed financial markets. This is mainly due to the fact that their markets are bank-based markets with highly regulated policies. Keywords: Financial Market Quality, Emerging Economies, Financial Development, Financial market growth DOI: 10.7176/RJFA/12-6-08 Publication date: March 31 st 2021

Market Depth, Leverage, and Speculative Bubbles

Abstract We develop a model of rational bubbles based on leverage and the assumption of an imprecisely known maximum market size. In a bubble, traders push the asset price above its fundamental value in a dynamic way, driven by rational expectations about future price developments. At a previously unknown date, the bubble will endogenously burst. Households optimally decide whether to lend to traders with limited liability. Bubbles increase welfare of the initial asset holders, but reduce welfare of future households. We provide general conditions for the possibility of bubbles depending on uncertainty about market size, traders’ degree of leverage, and the risk-free rate. This allows us to discuss several policy measures. Capital requirements and a correctly implemented Tobin tax can prevent bubbles. Implemented incorrectly, however, these measures may create the possibility of bubbles and can reduce welfare.

Early Results on Depth of the Nascent Kenyan Derivative Market

Despite their importance in hedging against risk and reducing price uncertainty, derivative markets remain undeveloped or absent in many African countries. This paper describes market depth using key trends observed in the Kenyan derivatives market for the first 30 weeks of trading using mixed methods. Market depth was measured by the number of open interests of 142 trading days (30 weeks. The market was described using trend analysis, tests of means, and thematic analysis. The results revealed a market highly dominated by one company's single stock futures (Safaricom Plc), whose overall trade was 68% of the 6179 open contracts. Further, the market has strong weekly swings fluctuating from no trade to a high of 326 and a weekly average of 206 contracts. The market segment of single stock futures is significantly deeper than that of equity index futures. The qualitative study attributed the results to limited knowledge on derivatives amongst investors, unclear market policies, few derivatives products, and skepticism associated with developing financial markets. The Nairobi Securities Exchange (NSE) is advised to intensify investor education, introduce market makers, add new derivatives products, and transform the Nairobi Securities Exchange Clearing House into a full Central Counterparty (CCP) structure to accelerate market depth. This will create a pathway to market depth through efficiency and reduction of operational risks.

Constrained Optimal Execution in Limit Order Book Market with Power-shaped Market Depth

Instead of using the classical block-shaped market depth to build the optimal execution model, this work studies the constrained optimal execution problem in a limit order book (LOB) market with a power-shaped market depth. Different from the linear price impact derived from the framework of block-shaped market depth, the price impact generated from the framework of our power-shaped market depth becomes a nonlinear function, which is consistent with the empirical studies. We also consider a class of state-dependent upper and lower bound constraints on trading strategies, which includes non-negative constraint (or non-short selling constraint) as its special case. Even though both the power-shaped market depth and trading strategy constraints make it hardly to solve such an optimal execution problem analytically, we still develop some significant properties on the optimal execution policy and optimal execution cost of our model. From some illustrative examples, we find that the optimal execution policy derived from our model is quite different from the one generated from the model with the block-shaped market depth when the market exhibits finite resiliency. However, when the market resilience is infinite, the obtained result becomes different, i.e., the optimal execution policies derived from these two kind of models are equivalent. For a special model with the stochastic block-shaped market depth and infinite market resilience, we successfully derive the analytical solution for such an optimal execution problem by utilizing the state separation property induced from its structure. The revealed optimal execution strategy is a piece-wise affine function with respect to the current remaining position, which can be computed off-line efficiently by solving two coupled equations. Finally, due to its explicit solution, we utilize this optimal execution model to demonstrate that the model admits no price magnification opportunity for the two-sided trading strategy.

Linear Bayesian equilibrium in insider trading with a random time under partial observations

<abstract><p>In this paper, the insider trading model of Xiao and Zhou (<italic>Acta Mathematicae Applicatae, 2021</italic>) is further studied, in which market makers receive partial information about a static risky asset and an insider stops trading at a random time. With the help of dynamic programming principle, we obtain a unique linear Bayesian equilibrium consisting of insider's trading intensity and market liquidity parameter, instead of none Bayesian equilibrium as before. It shows that (i) as time goes by, both trading intensity and market depth increase exponentially, while residual information decreases exponentially; (ii) with average trading time increasing, trading intensity decrease, but both residual information and insider's expected profit increase, while market depth is a unimodal function with a unique minimum with respect to average trading time; (iii) the less information observed by market makers, the weaker trading intensity and market depth are, but the more both expect profit and residual information are, which is in accord with our economic intuition.</p></abstract>

A Stochastic Partial Differential Equation Model for Limit Order Book Dynamics

We propose an analytically tractable class of models for the dynamics of a limit order book, described through a stochastic partial differential equation with multiplicative noise for the order book centered at the mid-price, along with stochastic dynamics for the mid-price which is consistent with the order flow dynamics. We provide conditions under which the model admits a finite-dimensional realization driven by a (low-dimensional) Markov process, leading to efficient methods for estimation and computation. We study two examples of parsimonious models in this class: a two-factor model and a model in which the order book depth is mean reverting. For each model we perform a detailed analysis of the role of different parameters, study the dynamics of the price, order book depth, volume, and order imbalance, provide an intuitive financial interpretation of the variables involved, and show how the model reproduces statistical properties of price changes, market depth, and order flow in limit order markets.

How Deep is the Labor Market for Female Directors? Evidence from Mandated Director Appointments

We examine the depth of the labor market for female directors following an exogenous shock to demand caused by California Senate Bill 826. Despite a surge in female appointments, new female director qualifications remain stable when benchmarked to control groups, indicating a deep labor market. Relative to the same control groups, we likewise find little evidence that investors view female director appointments more negatively following the law. However, stock returns to new female director appointments do not offset negative returns to the 2018 enactment of the law, suggesting that overall, investors still anticipate negative effects.

Інфраструктурні проєкти в центрі глобального суперництва КНР і США: інституційні важелі вирішення проблем сталого економічного розвитку

The article is devoted to the study of the institutional aspects of investment promotion, competitiveness, economic growth and sustainable development in the context of the infrastructure confrontation between the China and the United States as a manifestation of geo-economic rivalry. It has been established that the determinants of effective infrastructure in the country are: the quality of management; harmonization of the regulatory framework; the legitimacy of the permitting system; quality of planning; transparency of procurement; the practice of public-private partnerships in the implementation of infrastructure projects and their contribution to GDP; the government's credit rating for obtaining loans for infrastructure spending; the depth of the local market to support the implementation of large-scale financial investments. The classification of infrastructure is given and the signs of sustainable infrastructure are highlighted from the standpoint of coоpetition - the search for a balance between the competition of infrastructure projects and cooperation in the field of sustainable development. It has been demonstrated that the infrastructure rivalry between the United States and China is manifested in the implementation of megaprojects with the active use of the potential of regulatory competition. It has been established that standardization of projects will act as an instrument of access to capital markets and thereby determine the beneficiaries of sustainability as a new paradigm of international economic development.

Institutional and functional frameworks for capital markets in the Republic of Serbia

Globalization of financial flows, monetary integration, deregulation and cutting-edge information technology promote the growth of efficient capital market, as an integral part of national financial markets. The aim of this paper is to point out advantages and disadvantages of the development of relatively new capital market in the transition period of the Serbian economy. In the broadest sense, financial market is an organized place, where supply and demand for financial asset meet, forming the price of financial asset. In short, financial market includes all the institutions and procedures by which sellers and buyers of financial instruments are connected regardless of the nature of financial instrument. It enables unhindered funds and capital flow to the place where it can be employed most efficiently. Financial market development, depth and stability are crucial for economic growth and they are also a significant indicator of national market development in relation to its environment.

Determination of Strategic Spreads in East Asia

ABSTRACT This study develops a simple spread model to explain whether market dealers behave strategically when using electronic broking services. Our spread model stresses the role of an unexpected liquidity imbalance and its volatility for inventory risk, which contrasts sharply with previous studies that emphasised price volatility as the inventory risk. To capture a dealer’s strategic behaviour, we introduce a new concept of a strategic weighted spread and test this new spread using the full information maximum likelihood method with the GARCH (1,1) process. Daily spread data from 1 January 2006 to 20 December 2016 is used to explore strategic spreading at the end of a trading day in East Asia. Different effects on strategic spreads of liquidity depth in Asian financial markets are also investigated by comparing strategic spreads between the thin and deep markets. The evidence provides support for our hypothesis that a dealer behaves strategically to avoid the unexpected inventory risk, and that the magnitude of this influence depends on the depth of the financial market.

On the non-homogeneous effect of financial transaction taxes

This paper investigates the impact of a financial transaction tax (FTT) in a classic financial market setting. The benchmark analysis is based on an extension of the model presented in Kyle (1985). Opposed to the existing literature, I am able to find equilibrium values with a linear tax. Results of the benchmark model confirm standard findings of FTTs, such as an increased bid–ask spread and an overall less deep market. Importantly, I find that the introduction of a tax leads to a non–linear pricing function. In turn, the model predicts a decrease in market depth and trading aggressiveness for small trades, whereas for larger trades the introduction of an FTT only leads to increased prices and spreads.

Treasury Market Functioning During the COVID-19 Outbreak: Evidence from Collateral Re-use

<ns3:p>In March 2020, uncertainty over the COVID-19 pandemic caused severe stress in U.S. financial markets. Specifically, Fleming and Ruela (2020) document a severe impairment of Treasury market functioning, as indicated by a sharp increase in bid/ask spreads, a decline in market depth, and an increase in price impact measures.</ns3:p>

Dynamic Relation Between Economic Growth, Stock Market Depth and Macroeconomic Variables of Bangladesh

This study explores the dynamic relation between economic growth and stock market depth in the presence of three more macroeconomic indicators such as exchange rate, inflation and interest rate of Bangladesh. We use Johansen and Juselius (1990) test of co-integration and Vector Error Correction Model (VECM) to detect the possible short-run and long-run causal relation among the selected economic forces. The results of the study evidence that the lagged error-correct term of GDP (i.e., the proxy of economic growth) is found statistically significant in all three models. This manifest that GDP tends to converge to its long-run equilibrium path in response to changes in its regressors. But we find a complex network of causal linkage between the variables in the short-run. The findings of this study are of particular interest and importance to policymakers, financial managers, financial analysts and investors dealing with the Bangladesh economy and the Bangladesh stock market.

Stock market liquidity, the great lockdown and the COVID-19 global pandemic nexus in MENA countries

PurposeThe purpose of this paper is to investigate the impact of the global coronavirus (COVID-19) pandemic on stock market liquidity, while taking into account the depth and tightness dimensions.Design/methodology/approachThe author used a panel data regression on stock market dataset, representing 314 listed firms operating in six Middle East and North African (MENA) countries from February to May 2020.FindingsThe regression results on the overall sample indicate that the liquidity related to the depth measure was positively correlated with the growth in the confirmed number of cases and deaths and stringency index. Moreover, the market depth was positively related to the confirmed cases of COVID-19. The results also indicate that the liquidity of small cap and big cap firms was significantly impacted by the confirmed number of cases, while the stringency index is only significant for the liquidity depth measure. Moreover, the results regarding sectors and country level analysis confirmed that COVID-19 had a significant and negative impact of stock market liquidity.Research limitations/implicationsThis paper confirms that the global coronavirus pandemic has decreased the stock market liquidity in terms of both the depth and the tightness dimensions.Originality/valueWhile most empirical papers focused on the impact of the COVID-19 global pandemic on stock market returns, this paper investigated liquidity chock at firm level in the MENA region using both tightness and depth dimensions.

Relationship between Macroeconomic Indicators and Capital Markets Performance in Selected Southeastern European Countries

Abstract This study tests the weak form of the efficient capital markets theorem in five transition economies in Southeast Europe between 2005 and 2016. A panel pooled mean group estimator is used to examine the relationship between macroeconomic indicators and the performance of stock market indexes. This is a suitable estimator for these young frontier markets, given that they have yet to develop the breadth and depth of an advanced market—such as ample liquidity and traders—to aggregate cross-country data and use level series prime data instead of differentials of the same. These frontier capital markets are found to be weak form inefficient, meaning that stock prices do not reflect available current public information. In other words, when a market is transparent and investor behavior is rational, the macroeconomic data should be included in the value of the stock indexes. The five countries may benefit from bringing their capital markets legislation in line with those of developed countries and by improving corporate governance and transparency. This would boost investor trust and liquidity. The coverage of this research can be extended to find more standardized data values and develop additional factors not captured by this model.

REIT Spreads Around Dividend Cuts and Suspensions During the Financial Crisis

We examine bid-ask spreads, depths, and adverse selection components of bid-ask spreads for REITs announcing dividend cuts or suspensions before, during, and after the 2008 financial crisis. We compare measures of spread, market depth, and adverse selection components of bid-ask spreads across time periods and between event and non-event REITs. We find that on announcement days of dividend cuts and suspensions, bid-ask spreads of event REITs are narrower and market depths are larger than that of non-event REITs during and after the financial crisis periods. These findings suggest improved liquidity of REIT shares on announcement days of dividend events. We do not find any significant change in adverse selection components of bid-ask spreads. Our results regarding improved liquidity during the financial crisis period are consistent with Calomiris and Wilson. Calomiris and Wilson report that during the capital crunch in the 1930s, banks facing wider bid-ask spreads used dividend cuts as a way to preserve capital to avoid selling equity in a low-liquidity or high-transaction cost environment (wider bid-ask spread).

Augmenting Markets with Mechanisms

Abstract We explain how the common practice of size-discovery trade detracts from overall financial market efficiency. At each of a series of size-discovery sessions, traders report their desired trades, generating allocations of the asset and cash that rely on the most recent exchange price. Traders can thus mitigate exchange price impacts by waiting for size-discovery sessions. This waiting causes socially costly delays in the rebalancing of asset positions across traders. As the frequency of size-discovery sessions is increased, exchange market depth is further lowered by the traders’ reduced incentive to bid aggressively on the exchange, further delaying the rebalancing of positions, and more than offsetting the gains from trade that occur at each of the size-discovery sessions.

Order Execution Probability and Order Queue in Limit Order Markets

The shaping of a limit order book illustrates the dynamics of the trading process, the changing pattern of the execution probability of limit orders therefore plays an important role. This paper presents a computable execution probability model for limit order market, as well as a numerical example that intuitively characterizes the changing pattern of the execution probability. The common effects of the lengths of both buy and sell queues on the execution probability are explored. In the limit book, the cumulative probability of limit orders is introduced as a crucial index of market depth to describe the shaping process which brings new insights into the structure of the order placement decision.

The effects of trade size and market depth on immediate price impact in a limit order book market

We compare trade size to the prevailing market depth at the best level in the limit order book to detect and account for zero impact trades in an immediate price impact model. Our model also incorporates standard trade attributes (trade size, market capitalization and volatility) in a dynamic setting. The incorporation of market depth information reduces the mean absolute/squared forecast error of an immediate price impact prediction by about 60%. After controlling for trade attributes, market depth, price impact dynamics and intra-and inter- day periodicities (in order of relative importance) all improve the prediction of a trade’s price impact. We demonstrate the value of our model by showing that splitting a big order into a series of smaller trades results in a reduction of between 60% and 82% of the immediate price impact cost of the big order. We also find that our depth indicator helps with the prediction of order flow and permanent price impact.

Word-of-mouth communication, noise-driven volatility, and public disclosure

This paper examines how a firm adjusts its disclosure quality in response to technological innovations that improve investors' private information. We show that more precise private information can endogenously amplify supply shocks and, hence, increase noise-driven (or non-fundamental) price volatility. We study how the firm reacts to such changes and derive a necessary and sufficient condition under which the firm improves its disclosure quality when investors are informed with better private signals. We then apply our model to study investors' private word-of-mouth communication. Our analysis highlights a “dark side” of word-of-mouth communication and a call for better public disclosure even if private communication is assumed to be unbiased and truthful. We provide empirical predictions regarding how price volatility, market depth, and firms’ disclosure qualities would change as technological innovations, such as social media, facilitate information sharing among investors.