Price Discovery

Price discovery is a principal function of financial markets. Yet, especially for dealership markets, financial economists know little about how prices are determined. In this paper I analyze the process of price discovery in the multiple-dealer, interbank spot market for foreign exchange. I use DM/$ quotes to calculate interbank dealers’ “information shares,” their proportional contributions to the variance of innovations in the implicit, efficient exchange rate. These information shares are used to analyze relationships between price discovery and dealer characteristics. Unlike the U.S. equity markets, where regional exchanges contribute relatively little to price discovery, less-active interbank dealers play a large role, impounding most of the information into quotes. A pooled analysis of dealers’ intraday information shares indicates that the lower the relative bid-ask spread and the greater the number of regional foreign exchange branches, the higher is a dealer’s contribution...

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In this paper we present an equilibrium model of commodity spot (s t ) and futures (f t ) prices, with finite elasticity of arbitrage services and convenience yields. By explicitly incorporating and modelling endogenously the convenience yield, our theoretical model is able to capture the existence of backwardation or contango in the long-run spot-futures equilibrium relationship, s t = β 2 f t + β 3 . When the slope of the cointegrating vector β 2 > 1(β 2 < 1) the market is under long run backwardation (contango). It is the first time in this literature in which the theoretical possibility of finding a cointegrating vector different from the standard β 2 = 1 is formally considered.

We investigate whether and if so, how, corporate governance 'quality' 1 is related to the information flows from a company and how the share market and its agents respond. Specifically, we study links between the 'quality' of a firm's corporate governance (CGQ) and the informativeness of its disclosures. We employ six indicators of informativeness. They include document counts, properties of analysts' forecasts and a 'timeliness' metric, in the spirit of , that reflects the average speed of price discovery throughout the year. Our results suggest the answer to our question is 'Yes': better-governed firms do make more informative disclosures.

This study evaluates long-run relationships and short-run linkages between the private (unsecuritized) and the public (securitized) real estate markets of Australia, Netherlands, United Kingdom and the United States. Results indicate the existence of long-run relationships between the public and private real estate markets of each of the countries under consideration. This implies that for all countries, investors would not have realized long-term portfolio diversification benefits from allocating funds in both the private and public real estate markets since these assets are substitutable over the long run. Short-run analyses also reveal significant causal relationships between private and public markets of all countries under consideration. As expected, it was found that price discovery occurred in the public real estate market in that it leads but is not led by its private real estate market counterpart.

Prior to 1986, any opening position on feeder cattle futures contract must be settled with physical delivery after the last trading day. Due to dwindling commercial interests, Chicago Mercantile Exchange (CME) subsequently replaced the system with the cash settlement method. It was argued that cash settlement would help reduces the futures price's volatility. In this paper, we adopted stochastic volatility models to investigate this conjecture. The models allow for time varying volatility. Using 4 estimators based on mixtures of high, low, open and close prices, we found all estimators conclude that the volatility of the feeder cattle futures price decreased after switching from physical delivery to cash settlement. The change in the contract specification therefore enhances price discovery and risk management functions of the futures market. Concerning the higher moments of the volatility, different conclusions were derived. Range data, the Parkinson and the Rogers-Satchell estimators all indicate that cash settlement led to a reduction in the volatility of volatility. * The authors are grateful to Ted Juhl for helpful comments and suggestions. Of course, the usual disclaimers apply.

This paper investigates the lead-lag relationship in daily returns and volatilities between price movements of FTSE/ASE-20 futures and the underlying FTSE/ASE-20 cash index of the Athens Stock Exchange. The results suggest that there is a bidirectional causality between spot and futures returns, rejecting the usual result of futures leading spot market. However, spot market seems to play a more important role in price discovery. Volatility spillovers across the two markets are examined by using a bivariate EGARCH(1,1) model. This model is found to capture all the volatility dynamics. The results indicate that the transmission of volatility is bidirectional. Any piece of information that is released by the cash market has an effect on futures market volatility, and vice versa. Nevertheless, the volatility spillover from spot to futures market is slightly stronger than in the reverse direction.

The lead–lag relationship in both returns and volatilities between spot and futures markets has been investigated extensively in the financial economics literature. Only a limited number of such studies have appeared on forward markets, primarily due to the lack of easy access to empirical data. This paper uses a unique database in over-the-counter Forward Freight Agreements (FFA) to investigate the issue. The underlying commodity is non-storable, being that of a shipping service, with the additional feature of transactions costs being higher in the spot market in comparison to the forward market. These features have interesting implications for the markets. At the practical level, the better understanding of the mean and variance dynamics can improve risk management and budget planning decisions.

We propose a new and intuitive risk-neutral valuation model for real estate derivatives which are linked to autocorrelated indices. We model the observed index with an autoregressive model which can be estimated using standard econometric techniques. The resulting index behavior can easily be analyzed and closed-form pricing solutions are derived for forwards, swaps and European put and call options. We demonstrate the application of the model by valuing a put option on a house price index. Autocorrelation in the index returns appears to have a large impact on the option value. We also study the effect of an over-or undervalued real estate market. The observed effects are significant and as expected.

The purpose of this section is to review pricing mechanisms in agriculture and food. We started by constructing a taxonomy and system of classification for pricing mechanisms that is rooted in economic theory. This framework was applied to 26 pricing mechanisms observed from the following product categories: � Beef � Hogs � Grains and oilseeds � Dairy � Poultry and

Economic return and volatility spillovers of derivatives markets on a number of assets have been extensively examined in the general economics literature. However, there are only a limited number of studies that investigate such interactions between freight rates and the freight futures, and no studies that also consider potential linkages with freight options. This study fills this gap by investigating the economic spillovers between time-charter rates, freight futures and freight options prices in the dry-bulk sector of the international shipping industry. Empirical results indicate the existence of significant information transmission in both returns and volatilities between the three related markets, which we attribute to varying trading activity and market liquidity. The results also point out that, consistent with theory, the freight futures market informationally leads the freight rate market, though surprisingly, freight options lag behind both futures and physical freight rates, thus not fulfilling their price discovery function. The documented three-way economic interactions between the related markets can be used to enhance budget planning and risk management strategies, potentially attract more investors, and thus, improve the liquidity of the freight derivatives market.

The paper analysed e-markets(e-mandis)in Karnataka with the objective of knowing farmers, traders, commission agents and market committee opinion about e-market, identify best practices, bottlenecks in implementation and impact on prices, market arrivals and competition by intensively studying groundnut markets in 16 e-markets and 16 none markets. The study used difference-indifference approach along with qualitative data to understand the impact of e-market. There was increased competition among traders and reduced scope for collusion, increased number of bids per lot from about six to eleven. There was 128 % increase in average prices in e-markets compared to only 88% in none markets between 2007 and 2015. And also there was significant reduction in price variability in e-markets (by 3%) compared to increase in none markets (1%). The difference-indifference regression results show that with the introduction of e-markets, prices increased by Rs.65/q after controlling for initial conditions. There was also an increase in average market arrivals by 1166 tons with the introduction of e-markets. All stakeholders mentioned that there was increased transparency and reduced delay in payment. However, still most of the e-markets are operating partially; hence there was a need to improve the system in Karnataka as well as in National Agricultural Market scheme. First and foremost is to increase awareness about the e-market processes and benefits to farmers. Improvement in broadband connectivity, placing the skilled manpower for uninterrupted operation of the system, setting up of help desks for farmers, traders and commission agents to place their orders and clarify doubts about e-market system are important for the success of e-market network. Although most of the farmers are in favor of the e-markets, a few traders and also commission agents are expressing their concern about the utility of the system.

Using intraday data, this study investigates the contribution to the price discovery of Euro and Japanese Yen exchange rates in three foreign exchange markets based on electronic trading systems: the CME GLOBEX regular futures, E-mini futures, and the EBS interdealer spot market. Contrary to evidence in equity markets and more recent evidence in foreign exchange markets, the spot market is found to consistently lead the price discovery process for both currencies during the sample period. Furthermore, E-mini futures do not contribute more to the price discovery than the electronically traded regular futures.

We analyse the links between credit default swaps (CDSs) and bonds and try to determine which is the leader in the price discovery process. As the respective sizes of the markets are quite different for sovereigns and corporates, we consider a sample including both categories. For each entity, we compare CDS premia with spreads on a generic 5-year bond. The results show that the CDS market has a lead over the bond market for corporates. Moreover, the CDS market's lead has been fuelled by the current crisis. This also holds for sovereigns, although not for low-yield countries.

Examination is made of the relative contributions to price discovery of the floor and electronically traded euro FX and Japanese yen futures markets and the corresponding retail on-line foreign exchange spot markets. GLOBEX electronic futures contracts provide the most price discovery in the euro; the on-line trading spot market provides the most in the Japanese yen. The floor-traded futures markets contribute the least to price discovery in both the euro and the Japanese yen markets. The overall results show that electronic trading platforms facilitate price discovery more efficiently than floor trading. Futures traders may also extract information from on-line spot prices. © 2006 Wiley Periodicals, Inc. Jrl Fut Mark 26:1131–1143, 2006

Trading halts have their proponents and opponents. Recent literature has examined the benefits of halts, if any, by studying the consequences of halts on order flow and price volatility. This study complements existing literature by examining the consequences of trading halts on price discovery. Our results indicate that stock price adjustments surrounding trading halts are conditioned on the underlying event that caused the halt. The weighted price contributions of all subsamples are concentrated in the halt period and some subsamples show significant price contribution in the prehalt period as well. We find minimal evidence of price discovery continuing after the halt is removed. In addition, cross-sectional analysis shows that price discovery in the pre-halt and halt periods are more pronounced for larger firms and for firms with specific news events.

Studies of cross-listings show that price discovery occurs primarily in home markets, and attribute the dominance to informational advantages surrounding companies on the home market. However, a portion of what is attributed to information advantages may originate from order execution advantages. For each listing, we create a composite measure of each exchange's order execution advantage. The composite summarizes advantages associated with trading cost, trading volume, market depth, and the burden to restore price parity after currency shocks. We develop tests designed to separate the contribution of order

Although single-stock futures (SSFs) are useful multi-purpose stock derivatives, they have not received much attention in developed markets. We analyze SSFs in the Indian market to understand their contribution in price leadership. The findings indicate that trades in the stock market contribute more to price discovery than trades in the SSF market (72% and 28%, respectively), while quotes in the SSF market are more price innovative than quotes in the stock market (39% and 61%, respectively). Our analysis suggests that while stock and SSF trade returns have predictive ability for each other, in the case of quotes, only SSF quotes have predictive ability for stock and SSF returns.

We investigate how price discovery occurs in the options markets through traders' trade size choice. By employing transactions data on all options traded on a sample of 100 firms, we show that informed traders fragment their orders into small (medium) trades for low (high) volume contracts. We also find that almost 60% of the price discovery occurs in the exchange with the largest market share for a given option, where informed traders favor medium size trades.

There is a wealth of literature on farm-retail price spread for different commodities and countries. However, research on price transmission and marketing margins in the transition economies is still limited. The paper analyses two specific aspects of transition: the larger probability of asymmetric price transmission and structural changes in the case of Hungarian beef chain. The article identifies the date of structural break applying the Gregory and Hansen procedure with recursively estimated breakpoints and ADF statistics. Exogeneity tests reveal the causality runs from producer to retail prices. Homogeneity is rejected, suggesting a mark-up pricing strategy. Price transmission analysis suggests that, despite the common belief, price transmission on the Hungarian beef meat market is symmetric on both long and short run.

We examine the effect of price limits on futures contracts where there exist options contracts on those futures that have no price limits. We establish that when options are trading, the futures price implied by put-call parity provides an accurate prediction of the unconstrained futures price. We also provide empirical evidence that futures trading volume decreases on limit hit days, and that some of this decline is effectively transferred to the options market. These facts suggest that price discovery shifts to the options market when limit hits occur on the futures market. We also document that the microstructure of the future's market on the next day is affected positively by the presence of options on limit days, as the presence of options lowers spreads and reduces intra-day price variability. This is consistent with the premise that price limits increase adverse selection, and that the increase is mitigated by the presence of options. In total, we find that options assist in price discovery in the presence of limits.

VECMs can detect trades that permanently move the markets in cross-listed stocks. We employ Gonzalo and Granger's (J. Business Econom. Stat. 13 (1995) 1) reduced-rank regressions and QGG test statistic to analyze the common factor weight attributable to three informationally-linked exchanges for DJIA stocks over 1988–1995. We distinguish this error correction approach to trading price adjustment from the information shares approach to quote price leadership. In 1988, a 72.2% mean common factor weight (fNYSE) approximated the NYSE's 86% share of the trades. However, by 1992 fNYSE had declined precipitously for 27 Dow stocks, averaging only 49.6%, despite an unchanged 86% share of the trades. By 1995, the NYSE's common factor weight had recovered, averaging 62.9% on 84% of the trades. We discuss three alternative microstructure-theoretic hypotheses that can confront this evidence.

In this paper we present an equilibrium model of commodity spot (s t ) and futures (f t ) prices, with finite elasticity of arbitrage services and convenience yields. By explicitly incorporating and modelling endogenously the convenience yield, our theoretical model is able to capture the existence of backwardation or contango in the long-run spot-futures equilibrium relationship, s t = β 2 f t + β 3 . When the slope of the cointegrating vector b 2 > 1 (b 2 < 1) the market is under long run backwardation (contango). It is the first time in this literature in which the theoretical possibility of finding a cointegrating vector different from the standard b 2 =1 is formally considered.

Trading is the mechanism of the economist's 'invisible hand,' the means by which price discovery occurs. We use daily shareholdings data from the Australian equities clearinghouse to investigate the impact of the trading imbalances of investor categories on stock returns. Our evidence does not contradict the behavioral finance assumption that the trading of individual investors contributes to price discovery. Furthermore, we find that, while the trading of all investor categories Granger-causes returns, returns Grangercause trading only for the individual investor category. That is, in the short term of up to 1 month, only individual investors engage in feedback trading.

In recent years, some of the most influential policies have been either tested or evaluated using experimental methods. Experiments have provided significant insights on the implications of different designs on market outcomes and the lessons learned have helped improve academic debate and the interaction between policy makers and researchers. In this paper, we provide an overview of experiments relating to environmental markets. Expenditure on environmental programs has been growing in importance yet it is controversial in current times due to the fiscal cuts around the world. Finding cost-effective ways of reaching environmental goals is thus an objective of most governments. Research using experiments can help isolate how individuals and regulators would respond to incentives and therefore identify the most effective programs.

Dynamic hedging effectiveness for soybean farmers in Rondonópolis (MT) with futures contracts of BM&F is calculated through optimal hedge determination, using the bivariate GARCH BEKK model, which considers the conditional correlations of the prices series, comparing the results with the minimum variance model effectiveness, calculated by OLS, the unhedged and the naïve hedge positions. The financial effectiveness of the dynamic

This article examines the recent regulatory developments with regard to short selling. We begin with a comprehensive compilation of emergency restrictions on short selling adopted in the current crisis. Because of the tendency of some regulators to retain certain restrictions permanently, it is important to understand the fundamental legal and economic arguments regarding short selling. These arguments have at their core the question of whether there exists a market failure. The available evidence on balance suggests that short selling restrictions hamper the price discovery process.

We investigate the price discovery process among the futures prices of soybean and soya meal contracts in the Dalian Commodity Exchange. Granger Causality Test, Co-i ntegration Test and Error Correction Model (ECM) will be used to measure soybean, and soybean meal future price. If the two commodities' future price have strong relati onshi p in short or long term, the portfolio of cross-species arbitrage was produced throug h Co-integration Relationshi p. Other factors such as liqui dity, transaction costs, and other market restrictions may produce an empirical lead-lag relationshi p between price changes in the two markets. Moreover, all the markets do not trade simultaneously for many assets and commodities. We select the main contract from November 15th, 2005 to March 28th, 2012, which contain 1547 data respecti vely. All the data can be di vi ded into two groups, one is from November 15th, 2005 to December 31th, 2010, which contain 1247 data res pecti vely; the other is from January 4th, 2011 to March 28th. Our test results suggest a strong bi-directional causality in futures prices. We also find that the soybean contract bears the burden of convergence between soybean and soymeal prices.

Land assets have become an important source of financing capital investments by subnational governments in developing countries. Land assets, often with billions of dollars per transaction, rival and sometimes surpass subnational borrowing or fiscal transfers for capital spending. While reducing the uncertainty surrounding future debt repayment capacity, the use of land-based revenues for financing infrastructure can entail substantial fiscal risks. Land sales often involve less transparency than borrowing. Many sales are conducted off-budget, which makes it easier to divert proceeds into operating budgets. This paper-a product of the Economic Policy and Debt Department, Poverty Reduction and Economic Management Network-is part of a larger effort in the department to develop knowledge products on subnational finance and fiscal reforms. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. You may contact lliu@ worldbank.org for more information.

This study investigates information asymmetry in the foreign exchange market by testing the hypothesis that top trading banks possess superior information on the macroeconomy because they process greater order flow, which, according to the micro-structure literature, helps them aggregate the dispersed information and feel the general movements of the economy. Examining the information share of the banks in the Reuters EFX system using indicative GBP–$US data over 5 years, we find that the top 10 banks, out of 100 quoting banks in the market, have a monthly average share of over 70% of total market information, and around 80% during some US macroannouncements. These results suggest the possibility of private information over public news in the foreign exchange market. Copyright © 2009 John Wiley & Sons, Ltd.

Most stock markets are characterized by a number of parallel operating trading systems which interact intensively with each other. Usually, smaller trading platforms take the leading domestic main market as a benchmark in the price discovery process and for closing open trading positions. But what happens if the smaller trading systems suddenly have to act without this benchmark platform? We examine the effects of the reduction of the daily business hours of a screen based main trading system while a parallel floor based trading system keeps on operating. We provide evidence that liquidity improves while informed trading and informational efficiency of prices decrease at the floor based trading system as a result of the no longer operating main market. While prior research on parallel trading focuses on changes due to a growing number of trading venues, we present the first evidence on market effects when the main trading platform reduces trading hours.

Given Japan's dominant position in the Asia-Pacific regional coal market and the continuing relatively low profitability of Australia's coal industry, the influence of the Japanese steel mills on coal pricing arrangements between Australia and Japan remains an issue in Australia. In Japanese fiscal year (JFY) 1996, the Japanese steel mills replaced benchmark pricing with the "fair treatment" pricing system whereby coal contract information is kept confidential. In this paper, Quandt's switching regime model is used to test for structural change in hedonic pricing relationships in the important Australia-Japan coking coal trade between JFY 1992 and 1997. There is statistical evidence of significant structural change in JFY 1996 for hard coking coal and in JFY 1995 for semisoft coking coal (when soft coking coal was merged with the semisoft category). The goodness of fit of the regressions is lower in each recent period. It is concluded that price discovery in the annual coal negotiations, particularly for hard coking coal, is relatively more difficult under fair treatment pricing. Crown

Statistics plays a leading role in finance. The explosive development of increasingly complex markets makes it more and more difficult for practitioners to correctly value financial asset. Statistical analysis has become a powerful tool for a better market valuation, taking a leading role in the development of new financial products that try to hedge the increasing amount of risks that an investor has to take. Statistics knowledge demand is steadily increasing in Hedge Funds, Investment Banking and Financial Institutions in general, where statistics students could developed a professional career. Finance can be seen as a way to motivate students on the applications of almost any statistical tool we would like to teach them, since we could always find an example where these techniques are put into practice.