Illiquidity And Micro Structure On The Financial Market (Essay Sample)

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RESEARCH PROPOSAL TEMPLATE

1. Proposed Title
The Impact of Liquidity, illiquidity and microstructure in the Financial Market
2. Background or Rationale of the Project
Many scholars have delved into the topic of the dynamics of the financial market liquidity but more especially on the correlation between liquidity, illiquidity, microstructure and inter-dealership. Many academicians and scholars have written several academic journals and books on this topic. There has also been raging debates on academic and professional platforms on the empirical and theoretical causes of liquidity and illiquidity in the financial market. This discussion began as far as 1960 by the macroeconomic researchers who have sharply differed on the real cause of illiquidity and liquidity and the mechanisms that need that the relevant agencies need to employ in to curb it. This disagreement has created different views amongst the thinkers and those conducting studies. This problem does not only affect Europe and the US but other continents like Asia and Africa as well( Green and Inman2007)
The macroeconomic researchers have made some substantial progress in this field more especially liquidity and illiquidity in the financial market with more focus on the stock market.
However, the crucial questions on the real factors that influence the financial sector, therefore, causing liquidity and illiquidity have not been resolved. Equally, there are divergence views on the role of an inter-dealer ship in the financial markets as well as the effects that it creates( Mohan 90).About that, studies on the microstructure in the financial market conducted, have elicited several questions related to the financial. Most researchers in this field, argue that the market microstructure as well as have a practical effect on the financial market, but they differ on the nature of the effects ( Goodhart 2008).
The market frictions like the information costs and actual transaction cause an inducement for the emanation of the commercial structure. The economic structures are a set of institutional, capital markets and contracts. There is a hypothesis that is put forward by Alvin (2012) that the legal environment has a massive effect on the liquidity and illiquidity in the financial sector. The problem this dissertation wants to solve is whether the illiquidity and liquidity in the financial market are affected by microstructure and inter-dealership and the relationship that exists between the two. The study will use the internationally recognized methods of measuring liquidity and illiquidity in the stock market (Harinder 60).
3. Preliminary Review of the Literature
This paper is closely related to the kind of research on the microstructure and the liquidity of the sovereign bond markets in the period when the financial market was facing one of the greatest stresses as explained by Engle et al. (2012) as well as Tomio and Uno (2013).Although several researchers have conducted studies on the microstructure of the government bond, there are very few studies that cover the most recent cases of the turbulence in the financial market. These crises include the 2008 financial crisis as well as the Eurozone together with the interventions of the monetary policy. The researchers have not focused their studies in the field of inter-dealership and microstructure ( Kieschnick et al.2008).
The only exceptions are that of Engle (2012), who came up with a proposal of a dynamic model of the order book and study. This study focuses on the dynamics of liquidity in the United States Treasury market between 2006 and 2010.They found out that there was a dramatic decrease of liquidity during the crisis and both volatility and liquidity show a feedback that is negative. In his research, Pelizzon(2013) found out that in the Italian market the study price and the liquidity discovery during the 2011 and 2012 Eurozone crisis affected the market massively. He discovered that the price discovery takes place in the future market however the liquidity discovery happened in the spot market. A study was conducted by Tomio and Uno (2014) on the microstructure of the government bond in the Italian government bond. This study was conducted during the 2011 and 2012 period. From the findings, there was a documentation of a strong link between the sovereign risk and the liquidity of the market as well as the positive impact created on the market liquidity of the central bank interventions( Ziets 2006).
This work is also related to the literature on the pricing anomalies and the limits of arbitrage.Gromb and Vayanos( 2010) gives a well-elaborated survey of the theory. Krishnamurthy elaborates on several empirical examples from the financial crises that took place in 2008.The most recent paper on the government bond market is by Hu et al. (2013) who comes up with a proposal on how to measure the market-wide liquidity in the treasury market by using the yield curve noise; this means the bond yield deviations from a curve that flat fitted. The findings from this research show that during the time of sufficient risk capital, the yield curve is made smooth by the arbitrage forces.
However, during the time of the funding illiquidity and when the risk aversion is high, there might be persistent of large deviations in the prices. This is in line with the findings of Pedersen (2009) and Duffie (2010).Musto, Nini and Schwartz (2014), found out that the characteristics of the liquidity of the individual bonds give an explanation of the pricing errors in the yield curve. It also shows that the investors who are highly levered have a tendency of demanding for the more liquid bond in the times of the financial stress and this exacerbates the discrepancies in the price.Longsta and Lustig study the mispricing that existed between the nominal and the inflation that is linked to the Treasury securities and found out that the basis becomes narrow as the arbitrage when there is a flow of arbitrage capital into the market( Zheng and Shen2008).
The paper will also examine the gilt market with a focus on the inter-dealer market. The paper is also related to several studies that have the aim of getting a fundamental understanding of the interdealer section in the market (Hybrid or OTC).The seminal paper will be from Ho and Stoll (1983) which shows how the interdealer market can make it possible for the dealers to a have a share of the risks that are associated with inventories. On the empirical side, Lyons (1995), to control the inventory, the FX dealer uses the inter-dealers division in a systematic manner. In overall, the available literature on the empirical segment shows that the inter-dealer segment makes it possible for the dealers to share risks in the different markets(Tovar 2008).
This study will contribute to this stream of literature by demonstrating that the price impact magnitude and the reversals that are related to the gilt purchases by the bank depends on the aggregate uncertainty of the market as well as the auction characteristics. Unlike the other previous studies, this paper will show the precise control of the Non-QE activities of the market on the gilt changes in the prices happen at the time of the QE auction and the day after the auction. These were the gaps left by the current literature on this topic. These findings are important for the scholars, financial markets dealers, and enthusiasts so that they can have an understanding of the dynamics that affect liquidity in the financial market.
In the above literature review, the main source of data was the Zen database that kept by the United Kingdom Conduct Authoruty.The Zen contains all the information and reports on the secondary market. The data covers all the activities of all the institutions involved. This data that was used by the literature review is valid and reliable because the UK government domiciles all the GEMS. The FCA institutions do the regulation of these financial transactions. This information has been cited many times by a number of researchers and as well as the credibility of these institutions makes it valid and reliable. The literature also cited other authorities in the field as well as the assessment of the current trends in the financial sector through newspapers and other media like television. Then through the use of the qualitative and quantitative methods, the data from these institutions were analysed (Pescatori et al. 2007).
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4. Research Questions (Aims) and Objectives
This research paper will use the microeconomic and network theory to investigate how the financial sector players and other forces trigger liquidity and illiquidity. The focus will be the time that countries are facing a financial crisis. The dynamic general equilibrium models will be used to show how the intermediation activities affect the financial sector. The netw...