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Microstructure Tutorial PDF
Microstructure Tutorial PDF
Tutorial
R/Finance 2009
24 April 2009
UIC ICFD
1
daler@uic.edu
Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
Who Am I
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
What Microstructure Is — and Is Not
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2
“So you short one stock...” omits a lot.
Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
What I Cover in a Microstructure Course
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
Asymmetric Information Models
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
Glosten-Milgrom (1985) Model
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
Glosten and Milgrom (1985) Model
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
Glosten-Milgrom Model: Setup
(
V w .p. 1 − δ
V ∼
V w .p. δ
(
Informed w .p. µ
Trader type T ∼ .
Uninformed w .p. 1 − µ
Traders take action S (buy/sell from MM), one at a time.
(
buy if V = V
Informed traders: S ∼ .
sell if V = V
(
buy w .p. 1/2
Uninformed traders: S ∼ .
sell w .p. 1/2
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
Glosten-Milgrom Model: Event Trees
1 j5 buy
jjjj
/ sell
3 I ; S =? 0
ggggg
µ
V = V ; T =? WW 1/2 kkk5
{= V
1−δ {{{
WWW+ kkk
/ sell
{{
1−µ
U; S =?
{{ 1/2
V =?C
CC
CC 0 /
C g3 I ; S =? SSS buy
δ CC! gg µ
ggg SS)
1
V V = V ; T =?W sell
WWWW+
1/2
1−µ
U; S =? T / buy
TTTT
) 1/2
t=0 t = 1, 2, . . . sell
V = security value (V , V)
T = trader type (Informed/Uninformed)
S = trader’s side (buy/sell) UIC ICFD
Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
Glosten-Milgrom Model: Likelihood of Buys and Sells
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
Glosten-Milgrom Model: Likelihood of V , V
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
Glosten-Milgrom Model: Bid, Ask, Spread
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
Glosten-Milgrom Model: Updating Bids and Asks
Bk+` =
= V P(V |k buys, ` + 1 sells) + V P(V |k buys, ` + 1 sells) (16)
V δ(1 − µ)k (1 + µ)`+1 + V (1 − δ)(1 − µ)k (1 + µ)`+1
= (17)
(1 − δ)(1 + µ)k (1 − µ)`+1 + δ(1 − µ)k (1 + µ)`+1
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
Glosten-Milgrom Model: Simulation Example
1.6
SBSBBBBSBSBSSBBSBSSBBSSBBBBBBBSBSSBBBBSBSBBSBBBSBB
1.4
0 10 20 30 40 50
Time
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
Glosten-Milgrom Model: Simulation Averages
2.0
µ = 0.5
1.8
1.8
Price
Price
1.6
1.6
1.4
1.4
0 10 20 30 40 50 0 10 20 30 40 50
Time Time
2.0
2.0
µ = 0.3
1.8
1.8
Price
Price
1.6
1.6
1.4
1.4
0 10 20 30 40 50 0 10 20 30 40 50
Time Time
δ = 0.3 δ = 0.5
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
Glosten-Milgrom Model: Other Results
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
One-Period Kyle (1985) Model
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
One-Period Kyle Model: Informed Trader vs. MM
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
One-Period Kyle Model: Setup
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
One-Period Kyle Model: Optimize, Compute Statistics
Now solve for the linear MM pricing and trader order parameters.
MM earns no expected profit4 , prices trade at p = E (v |y ).
Since v , y normal, form of E (v |y ) is like linear regression.
Cov(v , y )
p = E (v |y ) = E (v ) + (y − E (y )) (32)
Var(y )
βΣ0
= p0 + 2 (y − α − βp0 ) (33)
σu + β 2 Σ0
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4
Due to competition, again.
Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
One-Period Kyle Model: MM Price; Informed Order, Profit
√
Σ0
MM trade price p = E (v |y ) = λy + µ = · y + p0 (35)
2σu
σ 2 Σ0 Σ0
Value uncertainty Var(v |y ) = 2 u 2 = (36)
σu + β Σ0 2
(v − p0 )σu
Informed order x ∗ = βv + α = √ (37)
Σ0
(v − p0 )2 σu
Expected profit E (π) = (v − λx − µ)x = √ (38)
2 Σ0
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
One-Period Kyle Model: Commentary
5
Except data errors and adverse selection will hurt you.
6
Use uninformed orders to hide. UIC ICFD
7
Information in a Fisher sense.
Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
One-Period Kyle Model: Illiquidity Parameter
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
Multi-Period Kyle (1985) Model
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
Multi-Period Kyle Model: Further Definitions
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
Multi-Period Kyle Model: Dynamics Equations
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
Multi-Period Kyle Model: Solving for Dynamics
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8
Numerically or via Cardano’s formula.
Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
Multi-Period Kyle Model: Simulation
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
Multi-Period Kyle Model: Evolution of Parameters I
0.12
0.08
delta
0.04
0.00
0 10 20 30 40 50
Time
0.4
0.3
alpha
0.2
0.1
0.0
0 10 20 30 40 50
Time
25
20
15
beta
10
5
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0
0 10 20 30 40 50
Time
1.20
1.15
lambda
1.10
1.05
0 10 20 30 40 50
Time
0.4
0.3
Sigma
0.2
0.1
0.0
0 10 20 30 40 50
Time
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9
E.B.
Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
Multi-Period Kyle Model: Evolution of Actions
u
i i i
0.010
i i i i i
u
i i i i i i i i i i i i i i
i ui i i i i i i i i i i i i i i i i i i i i i ui i i i i u
u u u
u u u uu
Orders
u u u
u u u
0.000
u u
u u u u u
u
uu u u
uu u u
u
uu u u u u u
u u u
u u
-0.010
u
u
0 10 20 30 40 50
Time
True Price
2.4
Trade Prices
2.3
2.2
2.1
2.0
0 10 20 30 40 50
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Time
10
As with the Glosten-Milgrom model, I have yet to see plots
from anybody else who has simulated the Kyle model. UIC ICFD
11
Informed trades are shown as ’i’s; uninformed trades as ’u’s.
Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
If You Want More: to Read
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009
If You Want: to Support Work Like This
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Dale W.R. Rosenthal Market Microstructure Tutorial R/Finance 2009