José Penalva

SIGNAL ORDERINGS BASED ON DISPERSION AND THE SUPPLY OF PRIVATE INFORMATION IN AUCTIONS

This paper provides a novel approach to ordering signals based on the property that more informative signals lead to greater variability of conditional expectations. We define two nested information criteria (supermodular precision and integral precision) by combining this approach with two variability orders (dispersive and convex orders). We relate precision criteria with orderings based on the value of information to a decision maker. We then use precision to study the incentives of an auctioneer to supply private information. Using integral precision, we obtain two results: (i) a more precise signal yields a more efficient allocation; (ii) the auctioneer provides less than the efficient level of information. Supermodular precision allows us to extend the previous analysis to the case in which supplying information is costly and to obtain an additional finding; (iii) there is a complementarity between information and competition, so that both the socially efficient and the auctioneers optimal choice of precision increase with the number of bidders. Copyright 2010 The Econometric Society.

Where is the Value in High Frequency Trading

espanolAnalizamos el impacto de las operaciones que se realizan en mercados fi nancieros a gran velocidad utilizando un modelo con tres tipos de operadores: consumidores de liquidez, creadores de mercado y operadores de alta frecuencia. Nuestros cuatro resultados principales son: i) el impacto de las operaciones de liquidez sobre los precios es mayor cuando hay operadores de alta velocidad y este efecto adicional aumenta con el tamano de la operacion. En concreto, demostramos que la presencia de operadores de alta frecuencia reducen (aumentan) los precios que los consumidores de liquidez reciben cuando venden (adquieren) sus participaciones en Bolsa. ii) Aunque los creadores de mercado tambien pierden ingresos en sus operaciones con operadores de alta frecuencia, estas perdidas se ven compensadas por un mayor descuento de liquidez. iii) Las operaciones a gran velocidad aumentan la volatilidad en los precios. iv) El volumen de negocio se dobla ya que el operador de alta frecuencia intermedia en todas las transacciones entre consumidores de liquidez y creadores de mercado. Este volumen de negocio adicional proviene de transacciones especialmente disenadas para extraer parte de las ganancias de intercambio entre consumidores de liquidez y creadores de mercado, y no proviene ni de operaciones fundamentales ni de operaciones tontas (noise trading). En equilibrio, operadores de alta frecuencia coexisten con creadores de mercado tradicionales: Mientras que la competencia entre operadores de alta frecuencia reduce los benecios de los nuevos operadores, la existencia de operadores de alta frecuencia no expulsa a los creadores de mercado de la Bolsa. EnglishWe analyze the impact of high frequency trading in fi nancial markets based on a model with three types of traders: liquidity traders, market makers, and high frequency traders. Our four main fi ndings are: i) The price impact of the liquidity trades is higher in the presence of the high frequency trader and is increasing with the size of the trade. In particular, we show that the high frequency trader reduces (increases) the prices that liquidity traders receive when selling (buying) their equity holdings. ii) Although market makers also lose revenue to the high frequency trader in every trade, they are compensated for these losses by a higher liquidity discount. iii) High frequency trading increases the volatility of prices. iv) The volume of trades doubles as the high frequency trader intermediates all trades between the liquidity traders and market makers. This additional volume is a consequence of trades which are carefully tailored for surplus extraction and are neither driven by fundamentals nor is it noise trading. In equilibrium, high frequency trading and traditional market making coexist as competition drives down the profi ts for new high frequency traders while the presence of high frequency traders does not drive out traditional market makers.

On Information and Competition in Private Value Auctions

How much information does an auctioneer want bidders to have in a private value environment? We address this question using a novel approach to ordering information structures based on the property that in private value settings more information leads to a more disperse distribution of buyers’ updated expected valuations. We define the class of precision criteria following this approach and different notions of dispersion, and relate them to existing criteria of informativeness. Using supermodular precision, we obtain three results: (1) a more precise information structure yields a more efficient allocation; (2) the auctioneer provides less than the efficient level of information since more information increases bidder informational rents; (3) there is a strategic complementarity between information and competition, so that both the socially efficient and the auctioneer’s optimal choice of precision increase with the number of bidders, and both converge as the number of bidders goes to infinity.

Insurance with frequent trading: A dynamic analysis of efficient insurance markets

This paper extends existing insurance results on the type of insurance contracts needed for insurance market efficiency to a dynamic setting. It introduces continuosly open markets that allow for more efficient asset allocation. It also eliminates the role of preferences and endowments in the classification of risks, which is done primarily in terms of the actuarial properties of the underlying risk process. The paper further extends insurability to include correlated and catstrophic events. Under these very general conditions the paper defines a condition that determines whether a small number of standard insurance contracts (together with aggregate assets) suffice to complete markets or one needs to introduce such assets as mutual insurance.

Insuring California Earthquakes and the Role for Catastrophe Bonds

The 1994 Northridge earthquake sent ripples to insurance conpanies everywhere. This was one in a series of natural disasters such as Hurricane Andrew which together with the problems in Lloyds of London have insurance companies running for cover. This paper presents a calibration of the U.S. economy in a model with financial markets for insurance derivatives that suggests the U.S. economy can deal with the damage of natural catastrophe far better than one might think.

The Governance of Perpetual Financial Intermediaries

We reexamine the risk-sharing potential of intergenerational financial intermediaries, taking into account their governance structure. We argue that asset buffers of perpetual institutions are limited by the temptation of the living stakeholders to renegotiate contributions and distributions. We characterize the renegotiation constraint and show that it severely limits intergenerational risk sharing. Without renegotiation frictions, intermediaries cannot provide higher welfare than a market. The existence of (self-imposed) renegotiation costs relaxes the constraint. By forming a single monopolist intermediary, agents can further improve welfare.

Ultra-Fast Activity and Market Quality

This paper studies the intraday relationship between ultra-fast machine-driven activity (UFA) and market quality in automated equity markets. We find that higher UFA is associated with lower intraday market quality (greater quoted and effective spreads and lower depth). This effect is economically significant, and robust to different specifications, endogeneity tests, and alternative measures of UFA. Our results hold after controlling for volatility, periods of unusually high UFA (a proxy for quote stuffing), and periods where UFA is primarily driven by fleeting orders inside the spread (a proxy for spoofing and competition between liquidity providers).

Empirical Implications of Information Structure in Finite Extensive Form Games

We analyze what can be inferred about a games information structure solely from the probability distributions on action profiles generated during play; i.e., without reference to special behavioral assumptions or equilibrium concepts. Our analysis focuses on deriving payoff-independent conditions that must be met for one game form to be empirically distinguished from another. We define empirical equivalence and independence equivalence. The first describes when two game forms can never be distinguished based solely on the empirical distribution of player actions. As this turns out to be difficult to characterize, we introduce the latter, which describes two game forms that imply the same minimal sets of conditional independencies in every one of their empirical distributions. Our main contribution is to identify, for an arbitrary game form, the minimal set of conditional independencies that must arise in every one of its empirical distributions. We also introduce a new graphical device, the influence opportunity diagram of a game form which facilitates verifying independence equivalence, and hence provides a simple necessary condition for empirical equivalence.

Insurance and Tort: Coordination Systems and Imperfect Liability Rules

Three methods compete, both across and within different legal systems, for coordinating insurance or like benefits (social security, employer provided benefits, etc.) and Tort liability awards: Collateral Source Rule (cumulation), collateral benefits offset (deduction), and subrogation of insurer or provider. It is known in the economics literature that the optimal insurance contract contains subrogatory provisions (Shavell 1987, Sykes 2001). In the presence of a liability system, however, it has been overlooked that subrogation and its alternatives, however, make sense only in a world in which liability rules don’t operate perfectly. Under an imperfect strict liability regime, solely subrogation can induce optimal incentives for risk coverage. In addition, collateral offset reduces, compared to the other two alternative regimes, injurer’s incentives to take care. Under an uncertain negligence rule incorporating causation subrogation still outperforms the other regimes, and especially the benefits deduction rule. Finally, the paper also discusses in informal terms the apparently strong advantage in terms of administrative costs of the collateral offset over subrogation, and points out at several factors that might seriously undermine this opinion. The paper casts doubts upon the trend favoring the elimination of the Collateral Source Rule and adoption of deduction systems, which has already been shown empirically to reduce deterrence (Rubin and Shepherd 2007).