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Review of Quantitative Finance and Accounting

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01.01.2010 | Original Research

Trading costs and price discovery

verfasst von: Siu-Kai Choy, Hua Zhang

Erschienen in: Review of Quantitative Finance and Accounting | Ausgabe 1/2010

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Abstract

The price discovery roles of a set of related markets or securities have been investigated in many different settings where trading costs effect is often commingled with other trading arrangement factors. In Hong Kong, regular futures and mini futures contracts as well as their underlying spot asset are all traded on a same electronic trading platform. The trading arrangements thus provide us with a unique setting where we can isolate the impacts of transaction costs on price discovery. Using Hasbrouck’s (J Finance 50:1175–1199, 1995) information share approach, it is found that in Hong Kong, the regular futures contracts market plays a dominant role in price discovery while the mini futures and cash index markets play minor roles. The results in this paper provide an unequivocal support to the trading costs hypothesis.

Vorheriger Artikel The valuation of multivariate contingent claims under transformed trinomial approaches

Nächster Artikel Divergence of opinion and initial public offerings

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In terms of dollar value traded.

One may argue that (implicit) bid-asked spreads and market liquidity should be a part of order submission considerations. We do not consider those factors as a part of the transaction costs since they are endogenously determined. If bid-ask spread and market liquidity factors are considered as part of the transaction costs, the argument for the main futures to lead the mini market should be even stronger since the main futures markets are more actively traded. Furthermore, investors in both markets have access to a linked pool of liquidity since positions and margins are fungible. We thank an anonymous referee for point out this point to us.

For the relevant trading costs in the Hong Kong equity index markets, please see Table 1.

It was reported every minute before October 1999.

HKFE is now part of the Hong Kong Exchange and Clearing Limited (HKEx). Contract Specifications for the regular and mini Hang Seng Index Futures can be found at the website of HKEx: http://www.hkex.com.hk/prod/equityip/equityindexproducts.htm.

The HSI has been traded within the range of 8,200–15,000 during the sample period.

After April 1, 2003, the minimum commissions are negotiable. Our conversation with practitioners indicates that the main futures enjoy more trading cost advantage in the post-April, 2003 period. This is because that those trading main futures are more likely to be institutional investors (p. 9) and therefore have more negotiation power in the post-April, 2003 era. Our transaction data show that 99.38% of the trades in the mini market are with four mini contracts or less, which further confirms the survey results from the HKEx that the mini market is mainly used by small retail investors. We also did similar analyses, using 40 days of data before and 40 days of data after the deregulation in commission rates. The qualitative results are similar.

We only report the results for M = 9. In this case, for the two-security setting, total 12 parameters were estimated for each of the 791 trading days. We have also tried different lag length other than 9 and assumed parameters lie on a cubic segment. The results are not sensitive to those changes.

The results for the 15-s interval are reported to facilitate comparisons between the results for the two-security and three security settings. However, the results for the 5-s interval are not reported to conserve space.

Huang (2002) and Baillie et al. (2002) also find that the range of estimated information share becomes wider when the observation time interval becomes coarser.

We also did some further analyses for sub-samples before and after the deregulation in commission rates occurred in April 1, 2003. The results are very similar around the deregulation.

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Titel: Trading costs and price discovery
verfasst von: Siu-Kai Choy
Hua Zhang
Publikationsdatum: 01.01.2010
Verlag: Springer US
Erschienen in: Review of Quantitative Finance and Accounting / Ausgabe 1/2010
Print ISSN: 0924-865X
Elektronische ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-009-0118-y

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