Cross-Asset Market Order Flow, Liquidity, and Price Discovery with Robert Garrison, Pankaj Jain

Cross-asset market activity can be a channel through which illiquidity risks originating in one market can propagate to others. This paper examines the complex intra-day linkages between the U.S. equity securities market and the equity derivatives market using high-frequency data on S&P 500 index exchange-traded funds and E-mini futures contracts. The paper finds a positive, but short-lived, relationship between the two markets’ order flow activities, which relates to the supply, demand, and withdrawal of liquidity between the two markets. The paper also finds that cross-asset market order flow is a key component of liquidity and price discovery, particularly during periods of market volatility.

Intermediation Networks and Liquidity: Evidence from CDS Markets with Stathis Tompaidis

We examine the importance of intermediation trade networks towards the provision of market liquidity. We empirically evaluate how dealer inventory and trade influence the cost of single-name CDS data between 2010-2016, a period in which regulatory reforms may have influenced inventory costs for dealers, and the ease of interdealer trade. We find that as intermediation networks decline in interconnectedness and dealers with large inventories were forced to offset trades with clients, dealer inventory controls tighten and interdealer trade declined. The consequences has been higher transaction costs for clients and lower volumes as the costs of trade grows more dependent on the inventories of individual dealers rather than the collective inventory of all intermediaries.

An Agent-based Model for Crisis Liquidity Dynamics with Richard Bookstaber

Financial crises are often characterized by sharp reductions in liquidity followed by cascades of falling prices. Researchers are making progress in work to understand the levels of liquidity on a daily basis, but understanding the vulnerability of liquidity to market shocks remains a challenge. We develop an agent-based model with the objective of evaluating the market dynamics that lead the market supply of liquidity to recede during periods of crisis. The model uses a limit-order-book framework to examine the interaction of three types of traditional market agents: liquidity demanders, liquidity suppliers, and market makers. The paper highlights the implications of changes in market makers' ability to provide intermediation services and the heterogeneous decision cycles of liquidity demanders versus liquidity suppliers for crisis-induced illiquidity.

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Central Counterparty Default Waterfalls and Systemic Loss with Samim Ghamami, Simpson Zhang

Central counterparties (CCP) use default waterfalls to sequentially manage and allocate resources to cover defaults of clearing members and clients. A resilient waterfall can cover all payments. However, the amount of resources collected and how resources are allocated can create competing objectives for the CCP. In this paper, we model the trade-off between a waterfall's resiliency and the participation incentives of members. Our model measures the resiliency of a default waterfall's design, accounting for the interconnected nature of payment obligations and the distribution of losses among firms. We use a unique and comprehensive dataset containing both bilateral and centrally cleared CDS transactions to estimate the impact of default waterfall design on a systemic loss. We show that the distribution of segregated and shared resources in the waterfall strongly influences its resiliency and the participation incentives of member firms. Our results indicate that real-world CCP waterfall resource allocations and sizes are currently built to limit member losses at the potential expense of greater systemic losses.