MARKET MAKING WITH ALPHA SIGNALS

We show how a market maker employs information about the momentum in the price of the asset (i.e. alpha signal) to make decisions in their liquidity provision strategy in an order-driven electronic market. The momentum in the midprice of the asset depends on the execution of liquidity taking orders and the arrival of news. Buy market orders (MOs) exert a short-lived upward pressure on the midprice, whereas sell MOs exert a short-lived downward pressure on the midprice. We employ Nasdaq high-frequency data to estimate model parameters and to illustrate the performance of the market making strategy. The market maker employs the alpha signal to minimise adverse selection costs, execute directional trades in anticipation of price changes, and to manage inventory risk. As the market maker increases their tolerance to inventory risk, the expected profits that stem from the alpha signal increase because the strategy employs more speculative MOs and performs more roundtrip trades with limit orders.

Capital Structure Dynamics and Financing Imbalance: Evidence from an Emerging Economy

This paper considers the trade-off and pecking order theory in a unified framework and examines the influence of adverse selection costs on target adjustment process by investigating the relationship between firms’ financing imbalance and their target adjustment speed. Using a large dataset of 2718 non-financial and non-utility listed firms over a period of 2004–2005 to 2015–2016, the study observes that Indian firms adjust toward target leverage with a moderate adjustment speed of 32–36 percent. Moreover, firms with above-target debt make faster adjustment than firms with below-target debt, and firms with financing deficit make faster adjustment than firms with financing surplus. The extensions of target adjustment model by considering financing imbalance and direction of deviation together, and also by incorporating extent of deviation further reveal that firms try to avoid equity and prefer to deal in debt while making adjustments toward the target. In fact, firms deal in equity only when they are highly deviated from target leverage. All these findings suggest that adverse selection costs play significant role in the adjustment process. Therefore, though capital structure decisions of Indian firms are guided by trade-off theory, significance of pecking order arguments cannot be negated. This study makes important contributions to the existing literature as prior studies on impact of financing imbalance on adjustment speed are based on US which is very much different from emerging economies, particularly India.

Is Trading Fast Dangerous?

This chapter discusses the findings of the growing theoretical and empirical literature on trading speed in financial markets. The speed of trading has increased significantly in recent years, due to progress in information technologies and automation of the trading process. This evolution raises many questions about the effects of trading speed. It is argued that an increase in trading speed raises adverse selection costs but increases competition among liquidity providers and the rate at which gains from trade are realized. Thus, the effect of an increase in trading speed on market quality and welfare is inherently ambiguous. This observation is important for assessing empirical findings regarding the effects of trading speed and policy-making.

PENGARUH KEPEMILIKAN INSTITUSIONAL TERHADAP KARAKTERISTIK PASAR SAHAM DI BURSA EFEK INDONESIA

The role of institutional ownership in the financial markets became very important. However, until today there is no consensus among researchers about the influence of institutional ownership on the characteristic of stock market. Therefore, researchers are motivated to conduct further research the influence of institutional ownership on the characteristic of stock market. The research conducted at the Indonesian Stock Exchange with traded spread and adverse selection costs as dependent variable and institutional ownership as independent variable. In addition to institutional ownership, also used standard deviation of common stock price and trading volume as a control variable to clarify the relationship of institutional ownership on the characteristic of stock market. The study was conducted on 120 firms with observations in the period 2010-2011. All the required data obtained from the Indonesian Capital Market Directory. The results showed that: First, institutional ownership has a negative and significant effect on traded spread. Second, the variability of traded spread is able to be explained by the variability of institutional ownership, standard deviation of the stock price, and trading volume 24.8 percent. Third, institutional ownership has a negative and significant effect on adverse selection costs. Fourth, the variability of adverse selection costs is able to be explained by the variability of institutional ownership, standard deviation of the stock price, and trading volume 26.2 percent. Fifth, the relationship between institutional ownership to traded spread and adverse selection cost before and after entering the control variables remain negative and significant.

Organized Labor and Debt Contracting: Firm-Level Evidence from Collective Bargaining

ABSTRACT This paper employs a firm-level collective bargaining dataset to investigate the effect of labor, as an important stakeholder of a firm, on debt contracting. I conjecture and provide evidence that firms with strong organized labor prefer bank loans to public bonds because, by communicating with banks privately, unionized firms can reduce the adverse selection costs while preserving the information asymmetry with organized labor. Furthermore, I show that organized labor influences the structure of syndicated loans. When firms with strong unions withhold public disclosures, but communicate privately with lead lenders, heightened information asymmetry between the lead lenders and the participant lenders induces the lead lenders to retain larger shares of the loans and form more concentrated syndicates. Overall, this study demonstrates that the proprietary costs of disclosure related to organized labor significantly influence firms' debt contracting decisions and outcomes. Data Availability: Data are available from sources identified in the text.

How does corporate voluntary disclosure affect asymmetric information and adverse selection?

This paper investigates whether the extent of corporate voluntary disclosure mitigates asymmetric information and adverse selection in the Euronext Paris stock exchange. We apply a disclosure index as a proxy for the extent of voluntary disclosure and use different spread measures to estimate both asymmetric information and adverse selection. Our findings show a negative relationship between the disclosure index and asymmetric information and adverse selection proxies. An analysis of sub-indexes provides additional mixed results. Several asymmetric information measures are negatively related to the volume of financial, non-financial and voluntary governance information in corporate annual reports. Nevertheless, the effect of strategic information volume is statistically significant only for effective bid-ask spreads. On the whole, these results are consistent with the view that high corporate voluntary disclosure is associated with narrow spreads and low adverse selection costs

Adverse selection in a start-up long-term care insurance market

Common to all previous studies assessing the cost of adverse selection associated with genetics has been the assumption of an established market, i.e., the adverse selectors have been buying insurance at that rate for such a period that premiums have already absorbed it. Their analyses involve calculating the percentage difference between premiums in a market with adverse selection and one without adverse selection. They can shed no light on how the premiums would get to this stage over time and what losses might be incurred in the process. We take the modelling further by outlining a multiple state Markov model for a start-up market of long-term care insurance. With this model, we explicitly show the progression of adverse selection costs using the development of information that an insurer would gain from analysing the claims history of its existing business, to reprice premiums for new business. To overcome the complication of insurance benefit amounts, which depend on the value of previous benefit payments, we develop a simulation approach of estimating the expected present values of insurance benefits and premium payments. In applying our modelling to a UK setting, we find genetic testing of the apolipoprotein E gene (whose variants can cause a high risk of developing dementia) to be of a relatively small impact compared with our hypothetical state of intermediate dementia progression. Furthermore, we find that the government’s cap on care costs has little effect on adverse selection costs as it benefits only a small proportion of people.

Security Issuances in Hot and Cold Markets

Overwhelming evidence indicates that firms time market conditions to issue equity. I investigate the motivations for security issuances in hot and cold markets. While it is commonly believed that firms tend to exploit overvaluations to issue equity and overinvest in so-called 'hot' markets, which often results in lower future returns, I show that security issuances in certain periods with lower adverse selection costs are motivated by fundamentals such as capital expenditures and financial constraints, and that these issuances can create shareholder wealth. In contrast, firms that issue equity during periods of high sentiment experience a decline in future returns.