A Puzzle of Microstructure Market Maker Models, Issues 2004-2006
This study addresses the empirical viability of microstructure models of dealer price setting. New evidence is presented rejecting these models' specifications of how information asymmetry and inventory accumulation affect dealer pricing. This rejection is consistent with those of other dealer-level empirical studies. This study suggests a new modeling option may be to reconsider optimal price setting while relaxing assumptions that specify incoming orders as the only component through which dealer inventories evolve. This approach is consistent with inventory evolution data and with general equilibrium models' assumptions about currency markets.
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Reconsidering the Lyons 1995 Result
A Puzzle of Microstructure Market Maker Models
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abscissa assumptions asymmetric information effect August based dollar/DM dealer break tests brokered trading currency dealer daily cumulative data set Dealer Pricing dealer-level models dealers set denoted descriptive statistics DL model predictions DL Pricing Equation empirical end of days Equilibrium Microstructure equity market Evans and Lyons exchange rate depreciation exchange rate models F-test Fed intervention Figure Foreign Exchange Market full-information value Hence incoming order flow incoming purchases incoming trade intervention subsample inventory control inventory effects inventory evolution variable inventory level inventory management Journal of Financial left panel graphs Likelihood Ratio test Madhavan and Smidt Market Maker micro exchange rate million null hypothesis Number observation 795 observations 449 open macroeconomic order flow coefficient P-values parameter instability parity conditions percent price setting Prob R-squared receive incoming orders significant Sofianos Specialist specification Stoll structural breaks subsample estimates Sup-F test t-statistic Table third subsample transaction unexplained unmodeled inventory evolution vector auto regression Wald test