We investigate the impact of two central bank policies, asset purchases and asset lending, on the search frictions in the government bond market in Japan. We build a search-theoretic model to explore the impact of a central bank’s securities lending facility (SLF) by introducing a central bank as a lender. We test model predictions using intraday data from an electronic platform for Japanese government bonds. First, we find large-scale asset purchases (LSAPs) increase order imbalance in the repurchase agreement (repo) market. Threshold analysis reveals that asset purchase amounts exceeding 0.18% of the outstanding, which corresponds to 38.98% of our sample, cause a significantly higher imbalance. Second, the SLF has a floor effect on the repo rate by affecting dealers’ choices between the repo market and the SLF. Third, the novel friction measures we test show that LSAPs and the SLF have opposite influences on bargaining power in the repo market.

Cover risk denotes the risk of short sellers being unable to deliver. Large-scale asset purchases (LSAPs) by the central bank substantially weaken borrowers' bargaining power in the government bond market. We estimate a variety of cover risk measures, such as the non-execution probability of repurchase agreement (repo) orders, rate concessions, and search duration, to test search-theoretic models' prediction. We find cover risk rises as the central bank holds larger proportions of a bond. Despite the bid quotes of unfilled orders being four times higher than those of filled orders, counterparties cannot be found. Aggressive LSAPs weaken dealers' market-making capability

We examine the strategic behavior of High Frequency Traders (HFTs) during the pre-opening phase and the opening auction of the NYSE-Euronext Paris exchange. HFTs actively participate, and profitably extract information from the order flow. They also post “flash crash” orders, to gain time priority. They make profits on their last-second orders; however, so do others, suggesting that there is no speed advantage. HFTs lead price discovery, and neither harm nor improve liquidity. They “come early to the party”, and enjoy it (make profits); however, they also help others enjoy the party (improve market quality) and do not have privileges (their speed advantage is not crucial).

Do competition and incentives offered to designated market makers (DMMs) improve market liquidity? Using data from the NYSE Euronext Paris, we show that exogenous changes in the contract design lead to a significant decrease in quoted and effective spreads. Roughly four- fifth of the liquidity improvement is attributable to the exogenous increase in competition among DMMs, with the remainder stemming from the changes in financial incentives. Our analysis shows that competition among DMMs is another important aspect of contract design in addition to well-studied aspects such as rebates and requirements.

We classify groups of traders with similar trading characteristics through cluster analysis. This is a first attempt, as far as we know, to use cluster analysis to identify trader groups. We use the inventory ratio, order cancellation ratio, order frequency, and number of stocks per trading server as proxies of behavioral characteristics. The combination of these four variables successfully separates a group of traders matching the key trading characteristics. We identify two groups that satisfy the high-cancellation and low-inventory conditions of high-frequency trading market makers (HFT-MMs). These HFT-MMs are differentiated from other fast traders by their avoidance of market orders and assignment of very small numbers of stocks per trading server to minimize latency. A comparative analysis of trading behaviors between calm and volatile periods using order submission data covering all market participants in ten-seconds intervals finds that HFT-MMs’ trading decisions are triggered by marketwide order flow and their inventory changes, but not price information. In the fast-moving market, the magnitude of HFT-MMs’ reactions is amplified and the time until a limit order is canceled shortens almost one-third the time under normal market conditions. Thus HFT-MMs remain liquidity providers in the market during both periods.

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We investigate the determinants of the term structures of market liquidity and bond yield in the case of the Quantitative Easing ( QE) programs implemented by the Bank of Japan (BoJ). We distinguish between two opposing effects of QE on the liquidity of Japanese Government Bonds, the which is gradually manifested as a negative impact on liquidity, due to the shrinkage in the available supply of bonds; and the which induces an immediate improvement in liquidity, reflecting BOJ's massive demand. Between 2011 and 2016, we find that government bonds show an improvement in liquidity through the spotlight effect, but also experience a deterioration in liquidity through the scarcity effect. As for the yield, both the spotlight and scarcity effects work in the same direction (i.e., they raise bond prices) against theoretical expectation. Illiquidity caused by scarcity amplifies the yield decline rather than adding to the illiquidity premium.

This paper examines the strategic behavior of High Frequency Traders (HFTs) during the pre-opening phase and the opening auction of the NYSE Euronext Paris exchange. Using data provided by the Base Européenne de Données Financières à Haute Fréquence (BEDOFIH), we find that HFTs actively participate in the pre-opening phase. Contrary to common wisdom, HFTs do not delay their order submission decisions until the very last moment of the pre-opening phase of the trading day. They are able to successfully extract information from the pre-opening order flow, as manifested by the potential profits they make on the positions they take in the opening auction. Furthermore, HFTs make profits on orders submitted in the last second before the opening auction; however, so do slow traders, suggesting that speed is not a necessary condition to make profits in these last second orders. HFTs lead the price discovery process during the pre-opening phase, and neither harm nor improve liquidity provision in the opening auction. Our analysis highlights that HFTs who “come early to the party” enjoy the party (they make profits), however, they also help the other market participants to enjoy the party (they improve market quality) and do not have a privileged entrance to the party (speed advantage is not a necessary condition to make profits).

We investigate the determinants of the term structures of bond yield and market liquidity in the context of the Quantitative Easing (QE) programs implemented by the Bank of Japan. Between 2011 and 2016, we find that Japanese government bonds (JGBs) show an improvement in liquidity through the spotlight effect but also experience a deterioration in liquidity through the scarcity effect. As for the yield, both the spotlight and scarcity effects work in the same direction (i.e., they raise bond prices). Overall, the prices of JGBs rise by reflecting only the strong demand from the QE, despite the deterioration in liquidity.

We examine the impact of the Quantitative Easing (QE) programs implemented by one of the largest central banks in the world on market liquidity in the sovereign bond market. We do so in the context of the Large Scale Asset Purchase (LSAP) program of the Bank of Japan (BoJ) and distinguish between two opposing effects of QE on the yield and liquidity of Japanese Government Bonds (JGBs): the “scarcity effect,” which results from the reduction in liquidity as a consequence of shrinkage in the available bonds in the market, and the “spotlight effect,” which improves liquidity, arising from focusing attention on individual bonds selected for purchase by the central bank. The spotlight effect thus has an immediate positive impact on bond liquidity; on the other hand, the scarcity effect is only gradually manifested as a negative impact on liquidity. Since the LSAP repeatedly involved the purchase of significant amounts of individual securities, it is important to disentangle these two effects from each other to assess the overall impact. In the case of the BoJ’s LSAP between 2011 and 2016, we find that, indeed, government bonds show an improvement in liquidity through the spotlight effect and then a deterioration in liquidity through the scarcity effect. The spotlight effect is associated with the BoJ’s clear announcements of the programs and purchases in subsequent operations. The scarcity effect is amplified in the latter’s Quantitative and Qualitative Easing and when the BoJ’s bond holding ratio for particular maturities rises above 59% and 37% for threeto 10-year bonds and bonds over 10 years, respectively, indicating the presence of a ratio threshold above which the relation between yield change and time to maturity is altered. Our results suggest, therefore, that an aggressive QE program can eventually adversely affect the government bond market’s liquidity and that the execution of such an LSAP program requires caution. JEL classification: C54, E43, E52, E58, G12, G14

We study whether the presence of low-latency traders (including high-frequency traders (HFTs)) in the pre-opening period contributes to market quality, defined by price discovery and liquidity provision, in the opening auction. We use a unique dataset from the Tokyo Stock Exchange (TSE) based on server-IDs and find that HFTs dynamically alter their presence in different stocks and on different days. In spite of the lack of immediate execution, about one quarter of HFTs participate in the pre-opening period, and contribute significantly to market quality in the pre-opening period, the opening auction that ensues and the continuous trading period. Their contribution is largely different from that of the other HFTs during the continuous period.

We examine the dynamic relation between credit risk and liquidity in the Italian sovereign bond market during the Euro-zone crisis and the subsequent European Central Bank (ECB) interventions. Credit risk drives the liquidity of the market: a 10% change in the credit default swap (CDS) spread leads to a 13% change in the bid-ask spread, the relation being stronger when the CDS spread exceeds 500 bp. The Long-Term Refinancing Operations (LTRO) of the ECB weakened the sensitivity of market makers’ liquidity provision to credit risk, highlighting the importance of funding liquidity measures as determinants of market liquidity.

We study whether the presence of low-latency traders (including high-frequency traders (HFTs)) in the pre-opening period contributes to price discovery in the subsequent opening call auction and the continuous trading session. Our analysis evokes shades of the debate on the switch from the current continuous auction in many markets to a periodic auction, affecting the speed advantage of low-latency traders. We empirically investigate these questions using a unique dataset based on server IDs provided by the Tokyo Stock Exchange (TSE), one of the largest stock markets in the world. Our data allow us to develop a more comprehensive classification of traders than in the prior literature, and to investigate the behavior of the different categories of traders, based on their capability for low-latency trading. We find that, perhaps due to the lack of immediate execution, about three quarters of the low-latency traders do not participate in the pre-opening period, but do participate in and dominate the continuous trading session. Furthermore, we find that the larger presence of low-latency traders in the trading of a stock in the pre-opening period as well as in the continuous session improves the price discovery process. Our results suggest that HFTs may not participate in trading in the periodic batch auction because of a lack of immediate execution, and that this large reduction in HFT participation may impede the quality of price discovery.

We examine the dynamic relation between credit risk and liquidity in the Italian sovereign bond market during the eurozone crisis and the subsequent European Central Bank (ECB) interventions. Credit risk drives the liquidity of the market. A 10% change in the credit default swap (CDS) spread leads to a 13% change in the bid-ask spread, the relation being stronger when the CDS spread exceeds 500 basis points. The Long-Term Refinancing Operations of the ECB weakened the sensitivity of market makers’ liquidity provision to credit risk, highlighting the importance of funding liquidity measures as determinants of market liquidity.

Commonality of liquidity refers to the linkages between liquidity across assets through common market-wide factors, while liquidity discovery refers to the transmission of liquidity between assets linked to each other through arbitrage. In the context of liquidity discovery, the transmission of liquidity shocks between the two assets is supported by the actions of two types of traders: marketmakers and arbitrageurs. These two types of players are motivated and constrained by distinctly dierent forces. This paper investigates the microstructure of the relationship between liquidity discovery, through changes in the quotes posted by market makers and the reactions of arbitrageurs, and price discovery, through the transmission of price shocks between markets. We use data from the cash and futures markets, at the millisecond level, in the context of the Italian sovereign bond markets during the recent Euro-zone sovereign bond crisis and, surprisingly, nd that: (i) even though the futures market leads the cash market in price discovery, the cash market leads the futures market in liquidity discovery, i.e., the willingness of market makers to trade (measured by market depth and bid-ask spread), and (ii) the liquidity in the cash market, and not in the futures market, has a signicant impact on the basis between the price of the futures contract and that of the cash bond that is cheapest to deliver. However, the interventions of the European Central Bank (ECB), during the Euro-zone crisis, had a signicant eect on the arbitrage mechanism, and hence

We study market microstructure and liquidity in the Italian sovereign bond market, the largest in the Euro-zone, using a unique new dataset, recently obtained from the Mercato dei Titoli di Stato (MTS), which provides tick-by-tick trade and quote data from individual broker-dealers. Our data cover the sovereign bonds of most European Union countries, for the period June 1, 2011 to November 15, 2012, which includes the Euro-zone crisis period. This database is unique for any market, in that it allows us to track individual orders and their revisions during the trading day. We document the strong non-linear relationship between changes in Italian sovereign risk and liquidity in the secondary bond market. We pinpoint which subset of bonds was the least aected by the worsening of the crisis, in terms of liquidity, and to what extent it was resilient to the deterioration of Italy’s creditworthiness. We document that, under conditions of stress, a fraction of market makers withdraws from the market, and hence frequent quote revisions do not necessarily translate into higher liquidity. We also examine how liquidity improved after intervention by the European Central Bank (ECB), through its Long-Term Renancing Operations (LTRO) and Outright Monetary Transactions (OMT) programs, starting in

Our empirical results show that the companies with higher market liquidity and shorter investment horizons by their shareholders tend to initiate market share repurchases. Such companies also have a higher value and percentage of repurchases with respect to total payout. Japanese companies’ unique shareholder ownership structure should have an influence on payout policies.

We investigate whether increasing the speed of order execution affects investor trading strategy and market liquidity. With the new trading platform Arrowhead, the Tokyo Stock Exchange has eliminated the three-second matching cycle, executes orders immediately, and instantaneously updates the limit order book, rendering computerized trading strategies more powerful. Since Arrowhead’s introduction, there have been an increase in execution frequency and a reduction in trade size, leading to declines in effective spread and increases in adverse selection costs. Among the trade intensity variables we examine, persistency of runs affects adverse selection cost more than share imbalance. High-speed quote revisions contribute to market depth.

A firm’s ownership structure influences both its liquidity and value. This paper investigate the above relation by introducing a new measure of latent investment horizon, a weighted average investment horizon computed from the firm’s ownership structure and the average investment horizon of various investor categories. We find that the latent investment horizon explains differences in liquidity and firm value among firms listed on the Tokyo Stock Exchange. Empirical results indicate that the longer the investment horizon, the lower the firm’s liquidity and value. In addition, concentrated ownerships by insider and cross-holding shareholders can lead to inferior liquidity and firm value. JEL Classification: G10, G32

A firm’s ownership structure influences both its liquidity and value. This paper introduces a new measure of latent investment horizon, a weighted average investment horizon computed from the firm’s ownership structure and the average investment horizon of various investor categories. We find that the latent investment horizon explains differences in liquidity and firm value among firms listed on the Tokyo Stock Exchange. Empirical results indicate that the longer the investment horizon, the lower the firm’s liquidity and value. In addition, concentrated ownerships by foreign (cross-holding) shareholders can lead to superior (inferior) liquidity and corporate governance after accounting for selection bias.