IDEAS home Printed from https://ideas.repec.org/a/inm/ormnsc/v55y2009i8p1377-1390.html
   My bibliography  Save this article

Experimentation in Financial Markets

Author

Listed:
  • Massimo Massa

    (INSEAD and CEPR, 77305 Fontainebleau Cedex, France)

  • Andrei Simonov

    (Finance Department, Eli Broad Graduate School of Management, Michigan State University, East Lansing, Michigan 48824)

Abstract

In this paper, we use a unique data set on the Italian interdealer bond market to empirically estimate the process of strategic experimentation. The results show how the information generated in the process of interdealer trading affects the incentive to experiment. Upon receipt of an order, dealers deliberately engage in trade with other dealers either to exploit the information contained in the order they receive or, if they are uncertain about its quality, to assess it by actively experimenting with other dealers. We therefore identify "hiding" and "experimenting" as main types of dealer strategies.

Suggested Citation

  • Massimo Massa & Andrei Simonov, 2009. "Experimentation in Financial Markets," Management Science, INFORMS, vol. 55(8), pages 1377-1390, August.
    • Handle: RePEc:inm:ormnsc:v:55:y:2009:i:8:p:1377-1390
    DOI: 10.1287/mnsc.1090.1030
    as

    Download full text from publisher

    File URL: http://dx.doi.org/10.1287/mnsc.1090.1030
    Download Restriction: no
    File URL: https://libkey.io/10.1287/mnsc.1090.1030?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Godfrey Keller & Sven Rady, 1999. "Optimal Experimentation in a Changing Environment," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 66(3), pages 475-507.
    2. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-1054, July.
    3. Frazzini, Andrea & Lamont, Owen A., 2008. "Dumb money: Mutual fund flows and the cross-section of stock returns," Journal of Financial Economics, Elsevier, vol. 88(2), pages 299-322, May.
    4. Madhavan, Ananth & Richardson, Matthew & Roomans, Mark, 1997. "Why Do Security Prices Change? A Transaction-Level Analysis of NYSE Stocks," The Review of Financial Studies, Society for Financial Studies, vol. 10(4), pages 1035-1064.
    5. Dirk Bergemann & Juuso Valimaki, 1997. "Market Diffusion with Two-Sided Learning," RAND Journal of Economics, The RAND Corporation, vol. 28(4), pages 773-795, Winter.
    6. Bergemann, Dirk & Valimaki, Juuso, 1996. "Learning and Strategic Pricing," Econometrica, Econometric Society, vol. 64(5), pages 1125-1149, September.
    7. Fishman, Michael J & Longstaff, Francis A, 1992. "Dual Trading in Futures Markets," Journal of Finance, American Finance Association, vol. 47(2), pages 643-671, June.
    8. Antonio Scalia & Valerio Vacca, 2001. "Does market transparency matter? A case study," BIS Papers chapters, in: Bank for International Settlements (ed.), Market liquidity: proceedings of a workshop held at the BIS, volume 2, pages 113-144, Bank for International Settlements.
    9. Leach, J Chris & Madhavan, Ananth N, 1993. "Price Experimentation and Security Market Structure," The Review of Financial Studies, Society for Financial Studies, vol. 6(2), pages 375-404.
    10. Flood, Mark D., 1994. "Market structure and inefficiency in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 13(2), pages 131-158, April.
    11. Smith, J. & Mcaleer, M., 1990. "On The Robustness Of Barro'S New Classical Unemployment Model," Papers 206, Australian National University - Department of Economics.
    12. Ho, Thomas & Stoll, Hans R., 1981. "Optimal dealer pricing under transactions and return uncertainty," Journal of Financial Economics, Elsevier, vol. 9(1), pages 47-73, March.
    13. M. J. Brennan, 1998. "The Role of Learning in Dynamic Portfolio Decisions," Review of Finance, European Finance Association, vol. 1(3), pages 295-306.
    14. F. Drudi, 2005. "Price Manipulation in Parallel Markets with Different Transparency," The Journal of Business, University of Chicago Press, vol. 78(5), pages 1625-1658, September.
    15. Lyons, Richard K., 1995. "Tests of microstructural hypotheses in the foreign exchange market," Journal of Financial Economics, Elsevier, vol. 39(2-3), pages 321-351.
    16. Chris Leach, J. & Madhavan, Ananth N., 1992. "Intertemporal price discovery by market makers: Active versus passive learning," Journal of Financial Intermediation, Elsevier, vol. 2(2), pages 207-235, June.
    17. Grinblatt, Mark & Han, Bing, 2005. "Prospect theory, mental accounting, and momentum," Journal of Financial Economics, Elsevier, vol. 78(2), pages 311-339, November.
    18. Brad M. Barber & Terrance Odean, 2008. "All That Glitters: The Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors," The Review of Financial Studies, Society for Financial Studies, vol. 21(2), pages 785-818, April.
    19. Huang, Roger D & Stoll, Hans R, 1997. "The Components of the Bid-Ask Spread: A General Approach," The Review of Financial Studies, Society for Financial Studies, vol. 10(4), pages 995-1034.
    20. Steven T. Berry, 1994. "Estimating Discrete-Choice Models of Product Differentiation," RAND Journal of Economics, The RAND Corporation, vol. 25(2), pages 242-262, Summer.
    21. Conway, Delores A & Reinganum, Marc R, 1988. "Stable Factors in Security Returns: Identification Using Cross-Validation," Journal of Business & Economic Statistics, American Statistical Association, vol. 6(1), pages 1-15, January.
    22. Conway, Delores A & Reinganum, Marc R, 1988. "Stable Factors in Security Returns: Identification Using Cross-Validation: Reply," Journal of Business & Economic Statistics, American Statistical Association, vol. 6(1), pages 24-28, January.
    23. repec:bla:jfinan:v:53:y:1998:i:5:p:1623-1656 is not listed on IDEAS
    24. repec:bla:jfinan:v:53:y:1998:i:3:p:1111-1130 is not listed on IDEAS
    25. repec:bla:jfinan:v:53:y:1998:i:5:p:1657-1703 is not listed on IDEAS
    26. Ho, Thomas S Y & Stoll, Hans R, 1983. "The Dynamics of Dealer Markets under Competition," Journal of Finance, American Finance Association, vol. 38(4), pages 1053-1074, September.
    27. Roell, Ailsa, 1990. "Dual-capacity trading and the quality of the market," Journal of Financial Intermediation, Elsevier, vol. 1(2), pages 105-124, June.
    28. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-1335, November.
    29. Pagan, Adrian, 1984. "Econometric Issues in the Analysis of Regressions with Generated Regressors," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 25(1), pages 221-247, February.
    30. Michael J. Fleming & Eli M. Remolona, 1999. "Price Formation and Liquidity in the U.S. Treasury Market: The Response to Public Information," Journal of Finance, American Finance Association, vol. 54(5), pages 1901-1915, October.
    31. Lyons, Richard K., 1997. "A simultaneous trade model of the foreign exchange hot potato," Journal of International Economics, Elsevier, vol. 42(3-4), pages 275-298, May.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Ledenyov, Dimitri O. & Ledenyov, Viktor O., 2015. "Wave function method to forecast foreign currencies exchange rates at ultra high frequency electronic trading in foreign currencies exchange markets," MPRA Paper 67470, University Library of Munich, Germany.
    2. Bjonnes, Geir Hoidal & Rime, Dagfinn, 2005. "Dealer behavior and trading systems in foreign exchange markets," Journal of Financial Economics, Elsevier, vol. 75(3), pages 571-605, March.
    3. Osler, Carol L. & Mende, Alexander & Menkhoff, Lukas, 2011. "Price discovery in currency markets," Journal of International Money and Finance, Elsevier, vol. 30(8), pages 1696-1718.
    4. Liu, Hong & Wang, Yajun, 2016. "Market making with asymmetric information and inventory risk," Journal of Economic Theory, Elsevier, vol. 163(C), pages 73-109.
    5. Vitale, Paolo, 1998. "Two months in the life of several gilt-edged market makers on the London Stock Exchange," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 8(3-4), pages 299-324, December.
    6. Imen Kouki & Mahfuzul Haque, 2009. "Tunisian Dealer Behaviour in FX Market," Journal of Emerging Market Finance, Institute for Financial Management and Research, vol. 8(3), pages 265-287, September.
    7. H. Henry Cao & Martin D. D. Evans & Richard K. Lyons, 2017. "Inventory Information," World Scientific Book Chapters, in: Studies in Foreign Exchange Economics, chapter 9, pages 363-413, World Scientific Publishing Co. Pte. Ltd..
    8. Madhavan, Ananth, 2000. "Market microstructure: A survey," Journal of Financial Markets, Elsevier, vol. 3(3), pages 205-258, August.
    9. Lyons, Richard K., 1998. "Profits and position control: a week of FX dealing1," Journal of International Money and Finance, Elsevier, vol. 17(1), pages 97-115, February.
    10. Jos Van Bommel & Jay Dahya & Zhihong Shi, 2010. "An empirical investigation of the speed of information aggregation: a study of IPOs," International Journal of Banking, Accounting and Finance, Inderscience Enterprises Ltd, vol. 2(1), pages 47-79.
    11. Martin D.D. Evans & Richard K. Lyons, 2017. "Order Flow and Exchange Rate Dynamics," World Scientific Book Chapters, in: Studies in Foreign Exchange Economics, chapter 6, pages 247-290, World Scientific Publishing Co. Pte. Ltd..
    12. Carol Osler & Geir Bjonnes & Neophytos Kathitziotis, 2016. "Bid-Ask Spreads in OTC Markets," Working Papers 102, Brandeis University, Department of Economics and International Business School.
    13. Leonardo Bargigli, 2021. "A model of market making with heterogeneous speculators," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 16(1), pages 1-28, January.
    14. Jagjeev Dosanjh, 2017. "Exchange Initiatives and Market Efficiency: Evidence from the Australian Securities Exchange," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 1-2017, January-A.
    15. Medina, Vicente & Pardo, Ángel & Pascual, Roberto, 2014. "The timeline of trading frictions in the European carbon market," Energy Economics, Elsevier, vol. 42(C), pages 378-394.
    16. Martin D. D. Evans & Richard K. Lyons, 2017. "How is Macro News Transmitted to Exchange Rates?," World Scientific Book Chapters, in: Studies in Foreign Exchange Economics, chapter 14, pages 547-596, World Scientific Publishing Co. Pte. Ltd..
    17. repec:uts:finphd:34 is not listed on IDEAS
    18. Li, Mingsheng & Eisenstadt, Robert C., 2005. "Price support and spreads in the IPO aftermarket: An empirical microstructure study," The Quarterly Review of Economics and Finance, Elsevier, vol. 45(4-5), pages 748-766, September.
    19. Ligon, James A. & Liu, Hao-Chen, 2013. "The relation of trade size and price contribution in a traditional foreign exchange brokered market," Pacific-Basin Finance Journal, Elsevier, vol. 21(1), pages 1024-1045.
    20. Levin, Eric J. & Wright, Robert E., 2004. "Estimating the profit markup component of the bid-ask spread: evidence from the London Stock Exchange," The Quarterly Review of Economics and Finance, Elsevier, vol. 44(1), pages 1-19, February.
    21. Victoria Saporta & Giorgio Trebeschi & Anne Vila, 1999. "Price formation and transparency on the London Stock Exchange," Bank of England working papers 95, Bank of England.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:inm:ormnsc:v:55:y:2009:i:8:p:1377-1390. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Chris Asher (email available below). General contact details of provider: https://edirc.repec.org/data/inforea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.