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Information and Market Microstructure. Chaoyang University of Technology Department of Finance Ming-Chin Lin. Outline. Part I The Literature Part II Empirical Observations Part III From Idea to Writing. Part I The Literature.

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Information and market microstructure

Information and Market Microstructure

Chaoyang University of Technology

Department of Finance

Ming-Chin Lin


Part I The Literature

Part II Empirical Observations

Part III From Idea to Writing

Part i the literature
Part I The Literature

  • Grossman and Stiglitz (AER, 1980)

  • Kyle (Econometrica, 1985)

Grossman and stiglitz aer 1980
Grossman and Stiglitz (AER, 1980)

• Joint normality of signals and payoffs

– Exponential Utility

– Linear demand functions

– Normally distributed price

• Rational Expectations

– Traders use correct models

Grossman and stiglitz model only informed traders
Grossman and Stiglitz Model: Only Informed Traders

• Informed Traders

– Continuum of identical traders

– Risk Averse with exponential utility

– Private signal = value + noise

– Rational

– Perfect Competitors

– Condition on Price

Grossman and stiglitz model add uninformed traders
Grossman and Stiglitz Model: AddUninformed Traders

• Uninformed Traders (= Market Makers)

– Continuum of identical traders

– Risk Averse with Exponential Utility

– Continuum of Perfect Competitors

– Condition on Price

• Could stop here (no other traders)

– Price = weighted average of “signal” and “prior” mean

– Private information can be inferred from price

Grossman and stiglitz model add noise traders
Grossman and Stiglitz Model: AddNoise Traders

•“Noise traders” : Who are they?

– Random endowment, hedging

– Liquidity needs

• Optimization by noise traders not modeled

Problem with competitive models
Problem with Competitive Models

• Large traders affect prices and know they affect prices.

• G&S impossibility results if perfect

competition assumed.

Kyle econometrica 1985 single period model
Kyle (Econometrica, 1985): Single-Period Model

• Informed Trader

– Monopolist,

exercises monopoly power

– Risk Neutral

• Market order model: This model

Uninformed Traders = Market Makers

– Perfect Competitors

– Risk Neutral

• Take other side of market orders

• Noise Traders trade randomly as in G&S.

• Microstructure: Informed and noise trades batched, anonymously.

Kyle 1985 equilibrium
Kyle (1985): Equilibrium

•Informed trader maximizes profits

(quadratic problem):

x = β*(V-P)

• Pricing Rule:

P = E{V | order flow = x + noise}

= u + λ * [order flow]


1/λ = [market depth] = stdev(noise) / stdev(V)

β = [market depth]/2

  • Price Informativeness

    Var(V|P) = ½ Var(V)

Bid – Ask Spread:

Order flow = -1, market maker sets

bid price = u + λ(-1) = u –λ

Order flow = 1, market maker sets

ask price = u + λ

  • 1/λ = [market depth] = stdev(noise) / stdev(V)

  • stdev(noise)

  • stdev(V)





Maug s definition of market depth
Maug’s Definition of Market Depth

the degree in which a trade moves the price

λ = E(P|B) – E(P|S) / H - L

λ= 0, infinitely deep market;

λ= 1, fully revealing

Market Depth : the probability that market prices are not fully revealing

= 1- λ= 1/2

Why does liquidity matter
Why does “liquidity” matter ?

market liquidity is essential in finance literature

The idealized assumptions :

- frictionless

- perfectly liquid markets

(traded at no cost)

- agents take prices as given.

If markets are not frictionless and are disturbed by some form of illiquidity?


if the assumptions thatprice-taking investors have the same information and are present in the market at all times are relaxed?

create an adverse selection problem form of illiquidity?

that implies differing bid and ask prices set by market maker.

In this case,

market liquidity is priced by the bid/ask spread

and the competitive equilibrium can not be applied.

Remark market microstructure
Remark: form of illiquidity?Market Microstructure

Loose Definition:

examining the process by which securities are traded affects prices, volume and trading behavior

Key concepts:

market efficiency

market liquidity

Order driven market
Order Driven Market form of illiquidity?

Quote driven market
Quote Driven Market form of illiquidity?

Empirical studies decompose bid ask spread
Empirical Studies: form of illiquidity?Decompose bid-ask spread

- Order Processing Costs

- Inventory Costs

- Adverse Selection Costs

Part ii empirical observations
Part II Empirical Observations form of illiquidity?

Monetary Liquidity -

in the sense of monetary factors, monetary policy

Market Liquidity -

measured by transaction costs,

trading volume, turnover rate,

bid-ask spread, market depth

Monetary policy form of illiquidity? Asset Prices

Monetary policy  Market Liquidity

Fig 1 fed target federal funds rate
Fig.1 Fed form of illiquidity?target federal funds rate

Source : Monetary Policy Report to the Congress July 15, 2004

Fed target federal funds rate cont
Fed target federal funds rate (cont.) form of illiquidity?

Source : Monetary Policy Report to the Congress Feb. 24, 2009

Fig 2 interest rate
Fig. 2 Interest rate form of illiquidity?

Source : Monetary Policy Report to the Congress Feb. 24, 2009

Fig 3 nyse turnover rate
Fig.3 NYSE Turnover rate form of illiquidity?

Source : NYSE

Nyse turnover rate cont
NYSE Turnover rate (cont.) form of illiquidity?

Fig 4 cboe vix index a measure of equity market volatility
Fig.4 CBOE VIX Index form of illiquidity?(a measure of equity market volatility)

Vix index 2007 2009 cont
VIX Index 2007-2009 form of illiquidity?(cont.)

從實際資料觀察 form of illiquidity?

圖一和圖二來看, 當 目標利率調高的同時, 30天期商業本票報酬率也走高.



1. 2006年 5~6 月份

油價高漲造成通膨壓力,市場預期 FOMC 持續調升利率的機率很高,此時的週轉率低 (圖三) 而波動程度高 (圖四);

2. 2007 年 8~9 月份

因為次級房貸危機造成經濟下跌的隱憂,市場預期 FOMC 持續調降利率的機率很高,此時的週轉率高 (圖三) 而波動程度低 (圖四)

此觀察結果似乎指出 然而若我們縮小範圍,觀察某一段特定時間的變化,又會有一些新發現。monetary policy and market liquidity 存在某種關聯。


Empirical findings
Empirical Findings然而若我們縮小範圍,觀察某一段特定時間的變化,又會有一些新發現。

Chordia, Roll and Subrahmanyam (JF, 2001)

Depth rises prior to macroeconomic data release and falls back toward its normal level on the day of announcement.

Empirical findings1
Empirical Findings然而若我們縮小範圍,觀察某一段特定時間的變化,又會有一些新發現。

Chordia, Sarkar and Subrahmanyam (RFS, 2005)

They found monetary expansion increases (decreases) in the federal fund rate lead to decreases (increases) in liquidity and increases (decreases) in stock and bond volatility.


因此不論是觀察實際資料或是實證研究的結果都指出建立 macro liquidity and market liquidity 之理論關係是值得探討的議題。

An example
An Example上述屬於實證研究,然關於理論方面的研究則尚不多見。

We focus on the transmission mechanisms :

from “market expectation about monetary stance of the Fed”

to “market liquidity in terms of

adverse selection costs”

Why is the linkage so important
Why is the linkage so important?上述屬於實證研究,然關於理論方面的研究則尚不多見。

  • 如果藉由理論探討所提供的各種可能結果,能夠了解貨幣政策將如何影響市場流動性,對於中央銀行制定貨幣政策以及進行公開市場操作時是很重要的參考。

  • 市場流動性影響價格揭露訊息的程度,透過不同水準的市場流動性可以映照出市場對於貨幣政策的預期看法和對基本面的信心。

Microstructure model
Microstructure Model上述屬於實證研究,然關於理論方面的研究則尚不多見。

藉由Kyle (1985) and Maug (1998)模型探討:

market maker 因為考慮面臨informed traders 產生的逆選擇問題所訂定的交易價格,在加入了市場對貨幣政策的預期看法後,將會有什麼影響?


if market beliefs about the Fed policy change,

how will the informativeness of price be affected?

Will the market depth or the adverse selection be more serious?

Part III From Idea to Writing上述屬於實證研究,然關於理論方面的研究則尚不多見。


  • 引起聽眾的興趣和注意

  • 以直覺的方式表達

  • 文章打散再重組

  • 技術性的地方可以省略

  • 不需太花俏

Idea 上述屬於實證研究,然關於理論方面的研究則尚不多見。怎麼來

  • 敏銳而細膩的觀察 – 對現象的關注

  • 深刻而嚴密的思考 – 對事理的分析

  • 活潑而豐富的想像 – 對本質的好奇

  • 抽象與具體的轉換 – 對方法的熟稔


  • 小說 電影 不同形式的藝術創作

  • 報章 雜誌 隨處可得的網路資訊

  • 不同領域成功或失敗的故事

  • 自己生活中的體會

Idea paper
上述屬於實證研究,然關於理論方面的研究則尚不多見。Idea 到Paper

  • 做和寫的差別

    good research

    ≠ good paper

    ≠ good publication

  • 寫作的講究

    小火慢燉 v.s. 大火快炒

  • 文章結構的佈局上述屬於實證研究,然關於理論方面的研究則尚不多見。

  • 邏輯的嚴密

  • 文筆的好壞

  • 中英文間的穿梭

  • 左腦和右腦交互


  • 一個動人的故事

  • 一個巧妙的開場

  • 一個引人入勝的鋪排

  • 一個高潮迭起的劇情

  • 一個讓人深思的結局

Three levels of writing
Three Levels of Writing上述屬於實證研究,然關於理論方面的研究則尚不多見。

  • First Level

    People focus solely on the document itself and on getting into shape

  • Second Level

    People try to improve their writing style

  • Third Level

    Good writing touches the soul

The End seeing that.