Abstract
The three essays of this thesis explore the relationship between returns, volatility, and liquidity provision in high-frequency financial markets. The essays are the result of my studies at the Department of Finance, and the Center of Financial Frictions (FRIC) at Copenhagen Business School.
The first paper, Jumps in Bond Prices, explores the behaviour of Treasury futures, and shows their prices to be more prone to price jumps compared to equity futures. Further, I find a positive relationship between trading activity and the frequency of jumps, indicating that an increase in trading activity leads to a reduction in liquidity which then leads to higher jump risk. For the cross-section of trading days, I show that jumps mostly occur during market openings, closings, and at announcement times. Downward jumps are more prevalent during market openings and announcement times, while upward jumps are more common during market closings.
The second paper, The Overnight Drift (co-authored with Nina Boyarchenko and Paul Whelan), documents that U.S. equity returns are large and positive during the opening hours of European markets. Consistent with models of inventory risk, we demonstrate a strong relationship with order imbalances at the close of the preceding U.S. trading day. Rationalizing unconditionally positive “overnight drift” returns, we uncover an asym-metric reaction to demand shocks: market sell-offs generate robust positive overnight reversals, while reversals following market rallies are much more modest. We argue that demand shock asymmetry can arise in inventory management models with time-varying market maker risk-bearing capacity.
The third paper, Dealer Participation in E-minis (co-authored with Nina Boyarchenko, Gyuri Venter and Paul Whelan), investigates the market depth in exchange traded mar-kets and argues that active dealer participation drives overall depth. The paper presents a model where dealers are subject to participation costs and a balance sheet constraint, which endogenize the number of dealers. The model predicts the dealer number to cause price reversals, and a negative dealer-volatility relationship driven by dealers’ balance sheet capacity. The predictions are tested and confirmed empirically. Further, we find that the depth and dealer number of the S&P 500 futures contract have decreased by 80%over a ten-year period from 2012 to 2022, and we relate this to increased costs for dealers.
The first paper, Jumps in Bond Prices, explores the behaviour of Treasury futures, and shows their prices to be more prone to price jumps compared to equity futures. Further, I find a positive relationship between trading activity and the frequency of jumps, indicating that an increase in trading activity leads to a reduction in liquidity which then leads to higher jump risk. For the cross-section of trading days, I show that jumps mostly occur during market openings, closings, and at announcement times. Downward jumps are more prevalent during market openings and announcement times, while upward jumps are more common during market closings.
The second paper, The Overnight Drift (co-authored with Nina Boyarchenko and Paul Whelan), documents that U.S. equity returns are large and positive during the opening hours of European markets. Consistent with models of inventory risk, we demonstrate a strong relationship with order imbalances at the close of the preceding U.S. trading day. Rationalizing unconditionally positive “overnight drift” returns, we uncover an asym-metric reaction to demand shocks: market sell-offs generate robust positive overnight reversals, while reversals following market rallies are much more modest. We argue that demand shock asymmetry can arise in inventory management models with time-varying market maker risk-bearing capacity.
The third paper, Dealer Participation in E-minis (co-authored with Nina Boyarchenko, Gyuri Venter and Paul Whelan), investigates the market depth in exchange traded mar-kets and argues that active dealer participation drives overall depth. The paper presents a model where dealers are subject to participation costs and a balance sheet constraint, which endogenize the number of dealers. The model predicts the dealer number to cause price reversals, and a negative dealer-volatility relationship driven by dealers’ balance sheet capacity. The predictions are tested and confirmed empirically. Further, we find that the depth and dealer number of the S&P 500 futures contract have decreased by 80%over a ten-year period from 2012 to 2022, and we relate this to increased costs for dealers.
| Original language | English |
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| Place of Publication | Frederiksberg |
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| Publisher | Copenhagen Business School [Phd] |
| Number of pages | 227 |
| ISBN (Print) | 9788775683192 |
| ISBN (Electronic) | 9788775683208 |
| DOIs | |
| Publication status | Published - 2024 |
| Series | PhD Series |
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| Number | 44.2024 |
| ISSN | 0906-6934 |