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Are leveraged and inverse ETFs the new portfolio insurers?
This paper studies Leveraged and Inverse Exchange Traded Funds (LETFs) from a financial stability perspective. Mechanical positive-feedback rebalancing of LETFs resembles the portfolio insurance strategies, which contributed to the stock market crash of October 19, 1987 (Brady Report, 1988). I show that a 1% increase in broad stock-market indexes induces LETFs to originate rebalancing flows equivalent to $1.04 billion worth of stock. Price-insensitive and concentrated trading of LETFs results in price reaction and extra volatility in underlying stocks. Implied price impact calculations and empirical results suggest that they contributed to the stock market volatility in the 2008-2009 financial crisis and in the second half of 2011 when the European sovereign debt crisis came to the forefront. Although LETFs are not as large as portfolio insurers of the 1980s and have not been proven to disrupt stock market activity, their large and concentrated trading could be destabilizing during periods of high volatility.
AUTHORS: Tuzun, Tugkan
Microstructure Invariance in U.S. Stock Market Trades
This paper studies invariance relationships in tick-by-tick transaction data in the U.S. stock market. Over the 1993?2001 period, the estimated monthly regression coefficients of the log of trade arrival rate on the log of trading activity have an almost constant value of 0.666, strikingly close to the value of 2/3 predicted by the invariance hypothesis. Over the 2001?14 period, the estimated coefficients rise, and their average value is equal to 0.79, suggesting that the reduction in tick size in 2001 and the subsequent increase in algorithmic trading resulted in a more intense order shredding in more liquid stocks. The distributions of trade sizes, adjusted for differences in trading activity, resemble a log-normal before 2001; there is clearly visible truncation at the round-lot boundary and clustering of trades at even levels. These distributions change dramatically over the 2001?14 period with their means shifting downward. The invariance hypothesis explains about 88 percent of the cross-sectional variation in trade arrival rates and average trade sizes; additional explanatory variables include the invariance-implied measure of effective price volatility.
AUTHORS: Kyle, Albert S.; Obizhaeva, Anna A.; Tuzun, Tugkan
Trader Positions and Marketwide Liquidity Demand
In electronic, liquid markets, traders frequently change their positions. The distribution of these trader position changes carries important information about liquidity demand in the market. From this distribution of trader position-changes, we construct a marketwide measure for intraday liquidity demand that does not necessarily depend on aggressive trading. Using a rich regulatory dataset on S&P 500 E-mini futures and 10-year Treasury futures markets, we show that this liquidity demand measure has a positive impact on prices. We then decompose our measure of liquidity demand into three components: aggressive, passive and mixed liquidity demand. Passive liquidity demand also has an impact on prices; a one standard deviation increase in passive liquidity demand is associated with 0.5 tick rise in prices for S&P 500 E-mini futures. In addition, we find that new information is incorporated into the prices when passive liquidity demanders take positions. By providing direct evidence, we contribute to the growing literature on the impact of passive limit orders.
AUTHORS: Onur, Esen; Roberts, John S.; Tuzun, Tugkan
Price Pressure and Price Discovery in the Term Structure of Interest Rates
We study the price pressure and price discovery effects in the U.S. Treasury market by using a term structure model. Our model decomposes yield curve shifts into two components: a virtually permanent change related to order flow and a transitory, price pressure effect due to dealer inventories. We find strong evidence that net dealer Treasury inventories has impact on the yield curve. Cash Treasury instruments in inventory have a larger impact on yields than futures contracts, suggesting that cash and futures inventories are not perfect substitutes. Price discovery in the level of interest rates is most strongly linked to non-dealer order flow in the 10-year futures contract, while price discovery in the slope of the curve is linked to order flow in the 10-year futures and the 5-year cash market.
AUTHORS: Mixon, Scott; Tuzun, Tugkan