A Dynamic Model of the Limit Order Book


Review of Financial Studies

novembre 2009, vol. 22, n°11, pp.4601-4641

Départements : Finance, GREGHEC (CNRS)

pas sous affiliation hecThis paper presents a model of an order-driven market where fully strategic, symmetrically informed liquidity traders dynamically choose between limit and market orders, trading off execution price and waiting costs. In equilibrium, the bid and ask prices depend only on the numbers of buy and sell orders in the book. The model has a number of empirical predictions: (i) higher trading activity and higher trading competition cause smaller spreads and lower price impact; (ii) market orders lead to a temporary price impact larger than the permanent price impact, therefore to price overshooting; (iii) buy and sell orders can cluster away from the bid-ask spread, generating a hump-shaped order book; (iv) bid and ask prices display a comovement effect: after, e.g., a sell market order moves the bid price down, the ask price also falls, by a smaller amount, so the bid-ask spread widens; (v) when the order book is full, traders may submit quick, or fleeting, limit orders.

A General Stochastic Volatility Model for the Pricing of Interest Rate Derivatives


Review of Financial Studies

2009, vol. 22, n°5, pp.2007-2057

Départements : Finance

We develop a tractable and flexible stochastic volatility multifactor model of the term structure of interest rates. It features unspanned stochastic volatility factors, correlation between innovations to forward rates and their volatilities, quasi-analytical prices of zerocoupon bond options, and dynamics of the forward rate curve, under both the actual and risk-neutral measures, in terms of a finite-dimensional affine state vector. The model has a very good fit to an extensive panel dataset of interest rates, swaptions, and caps. In particular, the model matches the implied cap skews and the dynamics of implied volatilities

Applying Regret Theory to Investment Choices: Currency Hedging Decisions

S. Michenaud, B. SOLNIK

CFA Digest

février 2009, vol. 39, n°1, pp.55-56

Départements : Finance

The authors develop a model that has two components of risk: traditional risk (volatility) and regret risk. They apply the model to currency hedging to demonstrate behavior that would be counterintuitive when considering only traditional risk. The model is limited to relatively simple decision constructs because of the intricacy of applying regret theory and is distinctly different from other loss aversion behavioral models.

Belief-free equilibria in games with incomplete information

J. Hörner, S. LOVO


mars 2009, vol. 77, n°2, pp.453-487

Départements : Finance, GREGHEC (CNRS)

We define belief-free equilibria in two-player games with incomplete information as se- quential equilibria for which players' continuation strategies are best-replies, after every history, independently of their beliefs about the state of nature. We characterize a setof payoffs that includes all belief-free equilibrium payoffs. Conversely, any payoff in the interior of this set is a belief-free equilibrium payoff.Keywords: repeated game with incomplete information; Harsanyi doctrine; belief-free equilibria.

Capital Market Imperfections and the Sensitivity of Investment to Stock Prices


Journal of Financial and Quantitative Analysis

juin 2009, vol. 44, pp.551-578

Départements : Finance, GREGHEC (CNRS)

Commonality in Liquidity: A Global Perspective

P. Brockman, DY. Chung, C. PERIGNON

Journal of Financial and Quantitative Analysis

août 2009, vol. 44, n°4, pp.851-882

Départements : Finance, GREGHEC (CNRS)

Mots clés : Liquidity, Commonality, Bid-Ask Spreads, Depths

We conduct a comprehensive study of commonality in liquidity using intraday spread and depth data from 47 stock exchanges. We find that firm-level changes in liquidity are significantly influenced by exchange-level changes across most of the world’s stock exchanges. Emerging Asian exchanges have exceptionally strong commonality, while those of Latin America exhibit little if any commonality. After documenting the pervasive role of commonality within individual exchanges, we examine commonality across exchanges. We find evidence of a distinct, global component in bid-ask spreads and depths. Local (exchange-level) sources of commonality represent roughly 39% of the firm’s total commonality in liquidity, while global sources contribute an additional 19%. We also investigate potential sources of exchange-level and global commonality. We show that commonality is driven by both domestic and U.S. macroeconomic announcements

Credit, Wages, and Bankruptcy Laws


Journal of the European Economic Association

septembre 2009, vol. 7, n°5, pp.939-973

Départements : Finance

We analyze how bankruptcy laws affect the general equilibrium interactions between credit and wages. Soft laws reduce the frequency of liquidations and thus ex post inefficiencies, but they worsen credit rationing ex ante. This hinders firm creation and thus depresses labor demand. Rich agents who need few outside funds can invest even if creditor rights are weak. Hence, they favor soft laws that exclude poorer agents from the credit market and reduce the competition for labor. Such laws can generate greater utilitarian welfare than under perfect contract enforcement: By barring access to credit to some agents, soft laws lower wages, which increases the pledgeable income of richer agents and decreases the liquidation rates they must commit to. When they induce strong credit rationing, however, soft laws are Pareto-dominated by tougher laws combined with subsidies to entrepreneurs

Equity and Cash in Intercorporate Asset Sales: Theory and Evidence

U. HEGE, S. LOVO, M. Slovin, M. Sushka

Review of Financial Studies

février 2009, vol. 22, n°2, pp.681-714

Départements : Finance, GREGHEC (CNRS)

Mots clés : Asset sales, means of payment, auctions, two-sided asymmetric information.

We develop a two-sided asymmetric information model of asset sales that incorporates the key differences from mergers and allows the information held by each party to be impounded in the transaction. Buyer information is conveyed through a first-stage competitive auction. A seller with unfavorable information about the asset accepts the cash offer of the highest bidder. A seller with favorable information proposes a take-it-or-leave-it counteroffer that entails buyer equity. Thus, the cash-equity decision reflects seller, but not buyer, information in contrast to theoretical and empirical findings for mergers. The central prediction of our model is that there are relatively large gains in wealth for both buyers and sellers in equity-based asset sales, whereas cash asset sales generate significantly smaller gains that typically accrue only to sellers. Our empirical results are consistent with the predictions of our theoretical model

Equity or Cash? The Signal Sent by the Way You Pay

M. Sushka, U. HEGE

Harvard Business Review

mai 2009, vol. 87, n°5, pp.22

Départements : Finance, GREGHEC (CNRS)

The article reports on a study of asymmetric market information and corporate transactions such as the purchase of assets. The researchers found that buyers want to pay with equity instead of cash when they believe that their shares are overvalued and sellers want to receive equity when they believe the asset will create value for the buyer.*ASSETS (Accounting)*CORPORATIONS -- Finance*INFORMATION asymmetry*RETURN on assets*CAPITAL*VALUE

Fight or Flight? Portfolio Rebalancing by Individual Investors

L. E. CALVET, J. Campbell, P. Sodini

Quarterly Journal of Economics

février 2009, vol. 124, n°1, pp.301-348

Départements : Finance, GREGHEC (CNRS)

This paper investigates the dynamics of individual portfolios in a unique data set containing the disaggregated wealth of all households in Sweden. Between 1999 and 2002, we observe little aggregate rebalancing in the financial portfolio of participants. These patterns conceal strong household-level evidence of active rebalancing, which on average offsets about one-half of idiosyncratic passive variations in the risky asset share. Wealthy, educated investors with better diversified portfolios tend to rebalance more actively. We find some evidence that households rebalance toward a greater risky share as they become richer. We also study the decisions to trade individual assets. Households are more likely to fully sell directly held stocks if those stocks have performed well, and more likely to exit direct stockholding if their stock portfolios have performed well; but these relationships are much weaker for mutual funds, a pattern that is consistent with previous research on the disposition effect among direct stockholders and performance sensitivity among mutual fund investors. When households continue to hold individual assets, however, they rebalance both stocks and mutual funds to offset about one-sixth of the passive variations in individual asset shares. Households rebalance primarily by adjusting purchases of risky assets if their risky portfolios have performed poorly, and by adjusting both fund purchases and full sales of stocks if their risky portfolios have performed well. Finally, the tendency for households to fully sell winning stocks is weaker for wealthy investors with diversified portfolios of individual stocks.