Charles M. Jones

Macroeconomic news and bond market volatility

We examine the reaction of daily Treasury bond prices to the releaseoof U.S. government macroeconomic news. These news releases (of employment and Producer Price Index data) are of interest because they are released on periodic, preannounced dates and because they cause substantial bond market volatility. We investigate whether these non-autocorrelated announcements give rise to autocorrelated volatility. We find that announcement-day volatility does not persist at all, consistent with a simple efficient markets model in which information is incorporated immediately into prices. We also find a large risk premium on these release dates. In contrast, excess returns over Treasury bills are zero on non-announcement dates in our 1979-1993 sample.

Information, trading, and volatility

We examine the effects of trading and information flows on the short-run behavior of stock prices by comparing the behavior of stock return volatility during trading and nontrading periods. We define nontrading periods as periods when exchanges and businesses are open but traders endogenously choose not to trade. After correcting for the bid/ask bounce and stickiness in quotes, we find that a large proportion of daily stock return volatility occurs without trades, especially for large firms. Furthermore, we provide new evidence that public (versus private) information is the major source of short-term return volatility.

What Do We Know About High-Frequency Trading?

This paper reviews recent theoretical and empirical research on high-frequency trading (HFT). Economic theory identifies several ways that HFT could affect liquidity. The main positive is that HFT can intermediate trades at lower cost. However, HFT speed could disadvantage other investors, and the resulting adverse selection could reduce market quality.Over the past decade, HFT has increased sharply, and liquidity has steadily improved. But correlation is not necessarily causation. Empirically, the challenge is to measure the incremental effect of HFT beyond other changes in equity markets. The best papers for this purpose isolate market structure changes that facilitate HFT. Virtually every time a market structure change results in more HFT, liquidity and market quality have improved because liquidity suppliers are better able to adjust their quotes in response to new information.Does HFT make markets more fragile? In the May 6, 2010 Flash Crash, for example, HFT initially stabilized prices but were eventually overwhelmed, and in liquidating their positions, HFT exacerbated the downturn. This appears to be a generic feature of equity markets: similar events have occurred in manual markets, even with affirmative market-maker obligations. Well-crafted individual stock price limits and trading halts have been introduced since. Similarly, kill switches are a sensible response to the Knight trading episode.Many of the regulatory issues associated with HFT are the same issues that arose in more manual markets. Now regulators in the US are appropriately relying on competition to minimize abuses. Other regulation is appropriate if there are market failures. For instance, consolidated order-level audit trails are key to robust enforcement. If excessive messages impose negative externalities on others, fees are appropriate. But a message tax may act like a transaction tax, reducing share prices, increasing volatility, and worsening liquidity. Minimum order exposure times would also severely discourage liquidity provision.

Shorting Restrictions: Revisiting the 1930s

Several events in the 1930s made shorting more difficult or impossible in the United States. In 1931, the NYSE banned shorting for two days and later prohibited shorting on a downtick. In 1932, brokers needed written authorization before lending a customers shares, and the U.S. Senate released a list of the biggest short sellers. In 1938, the tick test was tightened. Short interest and securities lending data indicate that each event made shorting more difficult. Average returns associated with the events are significantly positive, consistent with disagreement models. Liquidity is also affected. Recent U.S. regulatory changes echo these earlier restrictions.

Revealing Shorts: An Examination of Large Short Position Disclosures

By 2012, all European Union countries began requiring the disclosure of large short positions. This regime change reduced short interest, bid-ask spreads, and the informativeness of prices. After specific disclosures, short-run abnormal returns are insignificantly negative, but 90-day cumulative abnormal returns are –5.23%. We find disclosures are likely to be followed by other disclosures, especially when the initial discloser is large or centrally located, but there is no subsequent increase in short interest, and prices do not subsequently reverse. These results indicate that large short sellers are well-informed, and that disclosures are not being used to coordinate manipulative attacks.

Shorting at Close Range: A Tale of Two Types

We examine returns, order flow, and market conditions in the minutes before, during, and after NYSE and Nasdaq short sales. We find two distinct types of short sales: those that provide liquidity, and those that demand it. Liquidity-supplying shorts are strongly contrarian at intraday horizons. They trade when spreads are unusually wide, facing greater adverse selection. Liquidity-demanding shorts trade when spreads are narrow and tend to follow short-term price declines. These results support a competitive rational expectations model where both market-makers and informed traders short, indicating that these two shorting types are integral to both price discovery and liquidity provision.

Mandatory Disclosure, Asymmetric Information and Liquidity: The Impact of the 1934 Act

We study the effect of the Securities Exchange Act of 1934 on common stock bid-ask spreads and other information measures. Among other things, the 1934 Act mandated a complete, audited income statement and balance sheet. Prior to the 1934 Act, some firms disclosed sales or depreciation, and some chose not to. Some firms reported audited financials; some did not. If disclosures and audits reduce information asymmetries, the 1934 Act should have a differential effect across these stocks. We find that a firms disclosure status in 1933 has little to do with the evolution of its information measures. Overall, we find that cross-sectional differences in mandatory disclosure had little measurable effect on the degree of information asymmetry.

Potential Pilot Problems: Treatment Spillovers in Financial Regulatory Experiments

The total effect of a regulatory change consists of direct effects and indirect effects (spillovers), but the standard difference-in-difference approach measures only direct effects and ignores potential indirect effects. By examining the short-sale aggressiveness during the 2007 full repeal of the uptick rule by the SEC, we find that short sellers become much more aggressive across the board, even in control stocks where the uptick rule is already suspended, which is consistent with positive and significant indirect effects on control stocks. In contrast, for the 2005 partial uptick repeal, short sellers become more aggressive in treatment stocks without an uptick rule, and less aggressive in control stocks with an uptick rule in place, which is consistent with negative indirect effects. We provide supportive evidence that the positive indirect effects in 2007 might be driven by aggressive broad list-based shorting, which includes both control and treatment stocks, and the negative indirect effects in 2005 might result from substitutions between control and treatment stocks. We conclude that regulatory pilot designers should carefully consider potential spillovers.

Tracking Retail Investor Activity

We provide an easy method to identify purchases and sales initiated by retail investors using recent, widely available U.S. equity transactions data. Individual stocks with net buying by retail investors outperform stocks with negative imbalances by approximately 10 basis points over the following week. Less than half of the predictive power of marketable retail order imbalances is attributable to order flow persistence; contrarian trading (a proxy for liquidity provision) and public news sentiment explain little of the remaining predictability. There is suggestive (but only suggestive) evidence that retail marketable orders contain firm-level information that is not yet incorporated into prices.

Market Maker Revenues and Stock Market Liquidity

We use an 11-year panel of daily specialist revenues on individual NYSE stocks to explore the relationship between market-maker revenues and liquidity. If market makers suffer substantial trading losses, lenders may respond by increasing funding costs or reducing credit lines, and market makers should respond by reducing liquidity provision. The data indicate that when specialists in aggregate lose money on their inventories, market-wide effective spreads widen in the days or weeks that follow, even after controlling for stock returns, volatility, and volume. This suggests an important role for market-maker financial performance in explaining liquidity time-variation. Revenues at the specialist firm level explain liquidity changes in that firms assigned stocks. Revenues at the individual stock level do not explain changes in individual stock liquidity, consistent with a financial constraints model with broadly diversified intermediaries. Aggregate specialist revenues are increasing in conditional return volatility, as is revenue volatility. Specialist margins (specialist revenue per dollar of trading volume) are essentially constant across stocks, implying limited scope for cross-subsidization.