Comprehensive Market Microstructure Model: Considering the Inventory Holding Costs

Abstract

Abstract. The purpose of this study is to propose a structural market microstructure model and examine the intraday price and spread dynamics in a highly liquid market. We extend the model of Madhavan, Richardson, and Roomans to devise a comprehensive order indicator model that considers the order duration, order size, market liquidity, and most importantly, inventory holding costs. Our empirical analyses on the KOSPI200 futures market indicate that the inventory holding costs of liquidity suppliers explain a significant portion of model-implied spreads. Meanwhile, the duration and size of traded orders convey significant information content on the inventory holding component. Market liquidity is also an important consideration for futures traders who have to manage their inventory holding costs.

The directional information content of options volumes

“…Existing studies find inconsistent results as for the information content of trade and order sizes. Some strands of the literature find that large trades carry higher-quality information than that of smaller trades (Angelidis & Benos, 2009;Easley, Kiefer, & O'Hara, 1997;Holthausen, Leftwich, & Mayers, 1990;Ryu, 2013Ryu, , 2016Ryu, , 2017. These studies argue that directional informed investors make as many transactions as possible within a limited time to maximize their trading profits by exploiting their information superiority.…”

Informed options trading around holidays

“…Hasbrouck (1988, 1991) shows that both the information content and the price impact are greater for larger stock trades. Ahn et al (2010), Chung et al (2016), and Ryu (2013a, 2015a, 2016, 2017) find that large‐sized trades convey more information in the Korea Composite Stock Price Index (KOSPI) 200 derivatives markets. On the other hand, some studies suggest the existence of stealth trading, as proposed by Barclay and Warner (1993) and Chakravarty (2001).…”

The difference in the intraday return-volume relationships of spot and futures: a quantile regression approach

“…Third, the information asymmetry model is a dynamic trading model in which some market participants are better informed than others (Huang and Stoll, 1997;Madhavan et al, 1997;Ryu, 2011Ryu, , 2016Ryu, , 2017Chung et al, 2016). Kyle (1985) assumes that informed traders intentionally make gradual trades to avoid revealing private information too quickly and, thus, earn more profits.…”