Essays on Financial Market Structure and Design
| Author | : Mr. Haoxiang Zhu |
| Publisher | : |
| Total Pages | : |
| Release | : 2012 |
| Genre | : |
| ISBN | : |
Download Essays on Financial Market Structure and Design Book in PDF, ePub and Kindle
In this doctoral dissertation, I study financial market structure and design, namely how institutional features of financial markets affect price discovery, liquidity, search behavior, efficiency, and welfare. This dissertation consists of three chapters. The first chapter studies dark pools and price discovery. Dark pools are equity trading systems that do not publicly display orders. Orders in dark pools are matched within the exchange bid-ask spread without a guarantee of execution. Because informed traders tend to have common information regarding the asset value, they are more likely to cluster on the heavy side of the market and therefore face a lower execution probability in the dark pool, relative to uninformed traders. Consequently, exchanges are more attractive to informed traders, whereas dark pools are more attractive to uninformed traders. Under natural conditions, adding a dark pool alongside an exchange concentrates price-relevant information into the exchange and improves price discovery. The second chapter offers a dynamic model of opaque over-the-counter markets. I build a theoretical model of OTC markets, in which a seller searches for an attractive price by visiting multiple buyers, one at a time. The buyers do not observe contacts, quotes, or trades elsewhere in the market. A repeat contact with a buyer reveals the seller's reduced outside options and worsens the price offered by the revisited buyer. When the asset value is uncertain and common to all buyers, a visit by the seller suggests that other buyers could have quoted unattractive prices and thus worsens the visited buyer's inference regarding the asset value. This chapter is now published at the Review of Financial Studies, Volume 25, Issue 4, April 2012. The third chapter studies settlement auctions for credit default swaps (CDS). This chapter is the joint work with Songzi Du, a fellow Doctoral Candidate at the Graduate School of Business, Stanford University. We find that the one-sided design of CDS auctions used in practice gives CDS buyers and sellers strong incentives to distort the final auction price, in order to maximize payoffs from existing CDS positions. Consequently, these auctions tend to overprice defaulted bonds conditional on an excess supply and underprice defaulted bonds conditional on an excess demand. We propose a double auction to mitigate this price bias. We find the predictions of our model on bidding behavior to be consistent with data on CDS auctions.
