Angelo Ranaldo

Order aggressiveness in limit order book markets

I examine the information content of a limit order book in a purely order-driven market. I analyze how the state of the limit order book affects a traders strategy. I develop an econometric technique to study order aggressiveness and provide empirical evidence on the recent theoretical models on limit order book markets. My results show that patient traders become more aggressive when the own (opposite) side book is thicker (thinner), the spread wider, and the temporary volatility increases. Also, I find that the buy and the sell sides of the book affect the order submission differently.

Safe Haven Currencies

We study high-frequency exchange rates over 1993-2008. Based on the recent literature on volatility and liquidity risk premia, we use a factor model to capture linear and non-linear linkages between currencies, stock and bond markets as well as proxies for market volatility and liquidity. We document that the (Swiss) franc and Japanese yen appreciate against the US dollar when US stock prices decrease and US bond prices and FX volatility increase. These safe haven properties materialise over different time granularities (from a few hours to several days) and non-linearly with the volatility factor and during crises. The latter effects were particularly discernible for the yen during the recent financial crisis.

Liquidity in the Foreign Exchange Market: Measurement, Commonality, and Risk Premiums

We provide the first systematic study of liquidity in the foreign exchange market. We find significant variation in liquidity across exchange rates, substantial illiquidity costs, and strong commonality in liquidity across currencies and with equity and bond markets. Analyzing the impact of liquidity risk on carry trades, we show that funding (investment) currencies offer insurance against (exposure to) liquidity risk. A liquidity risk factor has a strong impact on carry trade returns from 2007 to 2009, suggesting that liquidity risk is priced. We present evidence that liquidity spirals may trigger these findings.

Realized Bond-Stock Correlation: Macroeconomic Announcement Effects

We investigate the effects of macroeconomic announcements on the realized correlation between bond and stock returns. Our results deliver insights into the dominating drivers of bond-stock comovements. We find that it is not so much the surprise component of the announcement, but the mere fact that an announcement occurs that influences the realized bond-stock correlation. The impact of macroeconomic announcements varies across the business cycle. Announcement effects are highly dependent on the sign of the realized bond-stock correlation which has recently gone from positive to negative. Macroeconomic announcement effects on realized bond and stock volatilities are also investigated.

Intraday patterns in FX returns and order flow

Using a comprehensive high-frequency foreign exchange dataset, we present evidence of time-of-day effects in foreign exchange returns through a significant tendency for currencies to depreciate during local trading hours. We confirm this pattern across a range of currencies and time zones. We also find that this pattern is reflected in order flow and suggest that both patterns relate to the tendency of market participants to be net purchasers of foreign exchange in their own trading hours. Data from a single market maker appears to corroborate that interpretation.

Wolf in Sheep's Clothing: The Active Investment Strategies Behind Index Performance

This paper argues that the commonly used market indices imply forms of active investment management in disguise. The selection and rebalancing rules make these indices highly exclusive and dynamic regarding their underlying components and significantly bias their performance. Any passive investment tracking these indices turns into an active strategy characterised by market timing and state-dependent performance. Evidence is provided that exclusive indices outperform (underperform) more inclusive peer indices in upward (downward) markets. The constitution and maintenance rules of exclusive indices correspond to a set of active trading and investment rules similar to momentum strategies.

Forecasting Realized (Co)Variances with a Block Structure Wishart Autoregressive Model

In modelling and forecasting volatility, two main trade-offs emerge: mathematical tractability versus economic interpretation and accuracy versus speed. The authors attempt to reconcile, at least partially, both trade-offs. The former trade-off is crucial for many financial applications, including portfolio and risk management. The speed/accuracy trade-off is becoming more and more relevant in an environment of large portfolios, prolonged periods of high volatility (as in the current financial crisis), and the burgeoning phenomenon of algorithmic trading in which computer-based trading rules are automatically implemented. The increased availability of high-frequency data provides new tools for forecasting variances and covariances between assets. However, there is scant literature on forecasting more than one realised volatility. Following Gourieroux, Jasiak and Sufana (Journal of Econometrics, forthcoming), the authors propose a methodology to model and forecast realised covariances without any restriction on the parameters while maintaining economic interpretability. An empirical application based on variance forecasting and risk evaluation of a portfolio of two US treasury bills and two exchange rates is presented. The authors compare their model with several alternative specifications proposed in the literature. Empirical findings suggest that the model can be efficiently used in large portfolios.

Hedge Fund Performance and Higher-Moment Market Models

The CAPM model comes up short when explaining the superior performance of hedge funds in the past. This article argues that the Markowitz mean-variance criterion underpinning the traditional CAPM may fail to capture systematic features characterizing hedge fund performance. The two-moment market model is extended to a higher-moment model to accommodate coskewness and cokurtosis. The authors note that the higher-moment approach is more appropriate for capturing the non-linear relation between hedge fund and market returns and accounting for the specific risk-return payoffs of each hedge fund investment strategy. The key result is that the two-moment pricing model on a stand alone basis may be misleading and may wrongly indicate insufficient compensation for the investment risk.

On the predictability of stock prices: A case for high and low prices

Contrary to the common wisdom that asset prices are barely possible to forecast, we show that that high and low prices of equity shares are largely predictable. We propose to model them using a simple implementation of a fractional vector autoregressive model with error correction (FVECM). This model captures two fundamental patterns of high and low prices: their cointegrating relationship and the long memory of their difference (i.e. the range), which is a measure of realized volatility. Investment strategies based on FVECM predictions of high/low US equity prices as exit/entry signals deliver a superior performance even on a risk-adjusted basis.

Precious Metals under the Microscope: A High-Frequency Analysis

Taking advantage of a trades-and-quotes database, the main stylized facts and dynamic properties of a time series related to spot precious metals, that is, gold, silver, palladium, and platinum, are documented. The behavior of spot prices, returns, volume, and selected liquidity measures is analyzed. A clear evidence of periodic patterns matching the trading hours of the most active markets, London, Zurich, New York, as well as Asian markets, is found. The time series of spot returns have thus properties similar to those of traditional financial assets with fat tails, asymmetry, periodic behaviors in the conditional variances, and volatility clustering. The empirical analyzes show, as expected, that gold is the most liquid and less volatile asset, whereas palladium and platinum are traded less.Taking advantage of a trades-and-quotes high-frequency database, we document the main stylized facts and dynamic properties of spot precious metals, i.e. gold, silver, palladium, and platinum. We analyze the behaviors of spot prices, returns, volume, and selected liquidity measures. We find clear evidence of periodic patterns matching the trading hours of the most active markets round-the-clock. The time series of spot returns have thus properties similar to those of traditional financial assets with fat tails, asymmetry, periodic behaviors in the conditional variances, and volatility clustering. The gold (platinum) is the most (least) liquid and less (most) volatile asset. Commonality in liquidities of precious metals is very strong.