Essays on Market Microstructure: Price Discovery and Informed Trading

Market microstructure is “the study of the trading mechanisms used for financial securities” (Hasbrouck (2007)). It seeks to understand the sources of value and reasons for trade, in a setting with different types of traders, and different private and public information sets. The actual mechanisms of trade are a continually changing object of study. These include continuous markets, auctions, limit order books, dealer markets, or combinations of these operating as a hybrid market. Microstructure also has to allow for the possibility of multiple prices. At any given time an investor may be faced with a multitude of different prices, depending on whether he or she is buying or selling, the quantity he or she wishes to trade, and the required speed for the trade. The price may also depend on the relationship that the trader has with potential counterparties. In this research, I touch upon all of the above issues. I do this by studying three specific areas, all of which have both practical and policy implications. First, I study the role of information in trading and pricing securities in markets with a heterogeneous population of traders, some of whom are informed and some not, and who trade for different private or public reasons. Second, I study the price discovery of stocks in a setting where they are simultaneously traded in more than one market. Third, I make a contribution to the ongoing discussion about market design, i.e. the question of which trading systems and ways of organizing trading are most efficient. A common characteristic throughout my thesis is the use of high frequency datasets, i.e. tick data. These datasets include all trades and quotes in a given security, rather than just the daily closing prices, as in traditional asset pricing literature. This thesis consists of four separate essays. In the first essay I study price discovery for European companies cross-listed in the United States. I also study explanatory variables for differences in price discovery. In my second essay I contribute to earlier research on two issues of broad interest in market microstructure: market transparency and informed trading. I examine the effects of a change to an anonymous market at the OMX Helsinki Stock Exchange. I broaden my focus slightly in the third essay, to include releases of macroeconomic data in the United States. I analyze the effect of these releases on European cross-listed stocks. The fourth and last essay examines the uses of standard methodologies of price discovery analysis in a novel way. Specifically, I study price discovery within one market, between local and foreign traders.

Essays on the Role of Time in Price Discovery (summary section only)

The purpose of this thesis is to examine the role of trade durations in price discovery. The motivation to use trade durations in the study of price discovery is that durations are robust to many microstructure effects that introduce a bias in the measurement of returns volatility. Another motivation to use trade durations in the study of price discovery is that it is difficult to think of economic variables, which really are useful in the determination of the source of volatility at arbitrarily high frequencies. The dissertation contains three essays. In the first essay, the role of trade durations in price discovery is examined with respect to the volatility pattern of stock returns. The theory on volatility is associated with the theory on the information content of trade, dear to the market microstructure theory. The first essay documents that the volatility per transaction is related to the intensity of trade, and a strong relationship between the stochastic process of trade durations and trading variables. In the second essay, the role of trade durations in price discovery is examined with respect to the quantification of risk due to a trading volume of a certain size. The theory on volume is intrinsically associated with the stock volatility pattern. The essay documents that volatility increases, in general, when traders choose to trade with large transactions. In the third essay, the role of trade durations in price discovery is examined with respect to the information content of a trade. The theory on the information content of a trade is associated with the theory on the rate of price revisions in the market. The essay documents that short durations are associated with information. Thus, traders are compensated for responding quickly to information

Word Sense Discovery and Disambiguation

The work is based on the assumption that words with similar syntactic usage have similar meaning, which was proposed by Zellig S. Harris (1954,1968). We study his assumption from two aspects: Firstly, different meanings (word senses) of a word should manifest themselves in different usages (contexts), and secondly, similar usages (contexts) should lead to similar meanings (word senses). If we start with the different meanings of a word, we should be able to find distinct contexts for the meanings in text corpora. We separate the meanings by grouping and labeling contexts in an unsupervised or weakly supervised manner (Publication 1, 2 and 3). We are confronted with the question of how best to represent contexts in order to induce effective classifiers of contexts, because differences in context are the only means we have to separate word senses. If we start with words in similar contexts, we should be able to discover similarities in meaning. We can do this monolingually or multilingually. In the monolingual material, we find synonyms and other related words in an unsupervised way (Publication 4). In the multilingual material, we ?nd translations by supervised learning of transliterations (Publication 5). In both the monolingual and multilingual case, we first discover words with similar contexts, i.e., synonym or translation lists. In the monolingual case we also aim at finding structure in the lists by discovering groups of similar words, e.g., synonym sets. In this introduction to the publications of the thesis, we consider the larger background issues of how meaning arises, how it is quantized into word senses, and how it is modeled. We also consider how to define, collect and represent contexts. We discuss how to evaluate the trained context classi?ers and discovered word sense classifications, and ?nally we present the word sense discovery and disambiguation methods of the publications. This work supports Harris' hypothesis by implementing three new methods modeled on his hypothesis. The methods have practical consequences for creating thesauruses and translation dictionaries, e.g., for information retrieval and machine translation purposes. Keywords: Word senses, Context, Evaluation, Word sense disambiguation, Word sense discovery.

On the Origin of Ideas : An Abductivist Approach to Discovery

The purpose of this study is to analyze and develop various forms of abduction as a means of conceptualizing processes of discovery. Abduction was originally presented by Charles S. Peirce (1839-1914) as a "weak", third main mode of inference -- besides deduction and induction -- one which, he proposed, is closely related to many kinds of cognitive processes, such as instincts, perception, practices and mediated activity in general. Both abduction and discovery are controversial issues in philosophy of science. It is often claimed that discovery cannot be a proper subject area for conceptual analysis and, accordingly, abduction cannot serve as a "logic of discovery". I argue, however, that abduction gives essential means for understanding processes of discovery although it cannot give rise to a manual or algorithm for making discoveries. In the first part of the study, I briefly present how the main trend in philosophy of science has, for a long time, been critical towards a systematic account of discovery. Various models have, however, been suggested. I outline a short history of abduction; first Peirce's evolving forms of his theory, and then later developments. Although abduction has not been a major area of research until quite recently, I review some critiques of it and look at the ways it has been analyzed, developed and used in various fields of research. Peirce's own writings and later developments, I argue, leave room for various subsequent interpretations of abduction. The second part of the study consists of six research articles. First I treat "classical" arguments against abduction as a logic of discovery. I show that by developing strategic aspects of abductive inference these arguments can be countered. Nowadays the term 'abduction' is often used as a synonym for the Inference to the Best Explanation (IBE) model. I argue, however, that it is useful to distinguish between IBE ("Harmanian abduction") and "Hansonian abduction"; the latter concentrating on analyzing processes of discovery. The distinctions between loveliness and likeliness, and between potential and actual explanations are more fruitful within Hansonian abduction. I clarify the nature of abduction by using Peirce's distinction between three areas of "semeiotic": grammar, critic, and methodeutic. Grammar (emphasizing "Firstnesses" and iconicity) and methodeutic (i.e., a processual approach) especially, give new means for understanding abduction. Peirce himself held a controversial view that new abductive ideas are products of an instinct and an inference at the same time. I maintain that it is beneficial to make a clear distinction between abductive inference and abductive instinct, on the basis of which both can be developed further. Besides these, I analyze abduction as a part of distributed cognition which emphasizes a long-term interaction with the material, social and cultural environment as a source for abductive ideas. This approach suggests a "trialogical" model in which inquirers are fundamentally connected both to other inquirers and to the objects of inquiry. As for the classical Meno paradox about discovery, I show that abduction provides more than one answer. As my main example of abductive methodology, I analyze the process of Ignaz Semmelweis' research on childbed fever. A central basis for abduction is the claim that discovery is not a sequence of events governed only by processes of chance. Abduction treats those processes which both constrain and instigate the search for new ideas; starting from the use of clues as a starting point for discovery, but continuing in considerations like elegance and 'loveliness'. The study then continues a Peircean-Hansonian research programme by developing abduction as a way of analyzing processes of discovery.

The Impact of Emissions Trading on the Price of Electricity in Nord Pool : Market Power and Price Determination in the Nordic Electricity Market

The objective of this thesis is to find out how dominant firms in a liberalised electricity market will react when they face an increase in the level of costs due to emissions trading, and how this will effect the price of electricity. The Nordic electricity market is chosen as the setting in which to examine the question, since recent studies on the subject suggest that interaction between electricity markets and emissions trading is very much dependent on conditions specific to each market area. There is reason to believe that imperfect competition prevails in the Nordic market, thus the issue is approached through the theory of oligopolistic competition. The generation capacity available at the market, marginal cost of electricity production and seasonal levels of demand form the data based on which the dominant firms are modelled using the Cournot model of competition. The calculations are made for two levels of demand, high and low, and with several values of demand elasticity. The producers are first modelled under no carbon costs and then by adding the cost of carbon dioxide at 20€/t to those technologies subject to carbon regulation. In all cases the situation under perfect competition is determined as a comparison point for the results of the Cournot game. The results imply that the potential for market power does exist on the Nordic market, but the possibility for exercising market power depends on the demand level. In season of high demand the dominant firms may raise the price significantly above competitive levels, and the situation is aggravated when the cost of carbon dioixide is accounted for. Under low demand leves there is no difference between perfect and imperfect competition. The results are highly dependent on the price elasticity of demand.

Pentitol phosphate dehydrogenases: Discovery, characterization and use in D-arabitol and xylitol production by metabolically engineered Bacillus subtilis

The ultimate goal of this study has been to construct metabolically engineered microbial strains capable of fermenting glucose into pentitols D-arabitol and, especially, xylitol. The path that was chosen to achieve this goal required discovery, isolation and sequencing of at least two pentitol phosphate dehydrogenases of different specificity, followed by cloning and expression of their genes and characterization of recombinant arabitol and xylitol phosphate dehydrogenases. An enzyme of a previously unknown specificity, D-arabitol phosphate dehydrogenase (APDH), was discovered in Enterococcus avium. The enzyme was purified to homogenity from E. avium strain ATCC 33665. SDS/PAGE revealed that the enzyme has a molecular mass of 41 ± 2 kDa, whereas a molecular mass of 160 ± 5 kDa was observed under non-denaturing conditions implying that the APDH may exist as a tetramer with identical subunits. Purified APDH was found to have narrow substrate specificity, converting only D-arabitol 1-phosphate and D-arabitol 5-phosphate into D-xylulose 5-phosphate and D-ribulose 5-phosphate, respectively, in the oxidative reaction. Both NAD+ and NADP+ were accepted as co-factors. Based on the partial protein sequences, the gene encoding APDH was cloned. Homology comparisons place APDH within the medium chain dehydrogenase family. Unlike most members of this family, APDH requires Mn2+ but no Zn2+ for enzymatic activity. The DNA sequence surrounding the gene suggests that it belongs to an operon that also contains several components of phosphotransferase system (PTS). The apparent role of the enzyme is to participate in arabitol catabolism via the arabitol phosphate route similar to the ribitol and xylitol catabolic routes described previously. Xylitol phosphate dehydrogenase (XPDH) was isolated from Lactobacillus rhamnosus strain ATCC 15820. The enzyme was partially sequenced. Amino acid sequences were used to isolate the gene encoding the enzyme. The homology comparisons of the deduced amino acid sequence of L. rhamnosus XPDH revealed several similar enzymes in genomes of various species of Gram-positive bacteria. Two enzymes of Clostridium difficile and an enzyme of Bacillus halodurans were cloned and their substrate specificities together with the substrate specificity of L. rhamnosus XPDH were compared. It was found that one of the XPDH enzymes of C. difficile and the XPDH of L. rhamnosus had the highest selectivity towards D-xylulose 5-phosphate. A known transketolase-deficient and D-ribose-producing mutant of Bacillus subtilis (ATCC 31094) was further modified by disrupting its rpi (D-ribose phosphate isomerase) gene to create D-ribulose- and D-xylulose-producing strain. Expression of APDH of E. avium and XPDH of L. rhamnosus and C. difficile in D-ribulose- and D-xylulose-producing strain of B. subtilis resulted in strains capable of converting D-glucose into D-arabitol and xylitol, respectively. The D-arabitol yield on D-glucose was 38 % (w/w). Xylitol production was accompanied by co-production of ribitol limiting xylitol yield to 23 %.

The effects of the 2004 reduction in the price of alcohol on alcohol-related harm in Finland : A natural experiment based on register data

Changes in alcohol pricing have been documented as inversely associated with changes in consumption and alcohol-related problems. Evidence of the association between price changes and health problems is nevertheless patchy and is based to a large extent on cross-sectional state-level data, or time series of such cross-sectional analyses. Natural experimental studies have been called for. There was a substantial reduction in the price of alcohol in Finland in 2004 due to a reduction in alcohol taxes of one third, on average, and the abolition of duty-free allowances for travellers from the EU. These changes in the Finnish alcohol policy could be considered a natural experiment, which offered a good opportunity to study what happens with regard to alcohol-related problems when prices go down. The present study investigated the effects of this reduction in alcohol prices on (1) alcohol-related and all-cause mortality, and mortality due to cardiovascular diseases, (2) alcohol-related morbidity in terms of hospitalisation, (3) socioeconomic differentials in alcohol-related mortality, and (4) small-area differences in interpersonal violence in the Helsinki Metropolitan area. Differential trends in alcohol-related mortality prior to the price reduction were also analysed. A variety of population-based register data was used in the study. Time-series intervention analysis modelling was applied to monthly aggregations of deaths and hospitalisation for the period 1996-2006. These and other mortality analyses were carried out for men and women aged 15 years and over. Socioeconomic differentials in alcohol-related mortality were assessed on a before/after basis, mortality being followed up in 2001-2003 (before the price reduction) and 2004-2005 (after). Alcohol-related mortality was defined in all the studies on mortality on the basis of information on both underlying and contributory causes of death. Hospitalisation related to alcohol meant that there was a reference to alcohol in the primary diagnosis. Data on interpersonal violence was gathered from 86 administrative small-areas in the Helsinki Metropolitan area and was also assessed on a before/after basis followed up in 2002-2003 and 2004-2005. The statistical methods employed to analyse these data sets included time-series analysis, and Poisson and linear regression. The results of the study indicate that alcohol-related deaths increased substantially among men aged 40-69 years and among women aged 50-69 after the price reduction when trends and seasonal variation were taken into account. The increase was mainly attributable to chronic causes, particularly liver diseases. Mortality due to cardiovascular diseases and all-cause mortality, on the other hand, decreased considerably among the-over-69-year-olds. The increase in alcohol-related mortality in absolute terms among the 30-59-year-olds was largest among the unemployed and early-age pensioners, and those with a low level of education, social class or income. The relative differences in change between the education and social class subgroups were small. The employed and those under the age of 35 did not suffer from increased alcohol-related mortality in the two years following the price reduction. The gap between the age and education groups, which was substantial in the 1980s, thus further broadened. With regard to alcohol-related hospitalisation, there was an increase in both chronic and acute causes among men under the age of 70, and among women in the 50-69-year age group when trends and seasonal variation were taken into account. Alcohol dependence and other alcohol-related mental and behavioural disorders were the largest category in both the total number of chronic hospitalisation and in the increase. There was no increase in the rate of interpersonal violence in the Helsinki Metropolitan area, and even a decrease in domestic violence. There was a significant relationship between the measures of social disadvantage on the area level and interpersonal violence, although the differences in the effects of the price reduction between the different areas were small. The findings of the present study suggest that that a reduction in alcohol prices may lead to a substantial increase in alcohol-related mortality and morbidity. However, large population group differences were observed regarding responsiveness to the price changes. In particular, the less privileged, such as the unemployed, were most sensitive. In contrast, at least in the Finnish context, the younger generations and the employed do not appear to be adversely affected, and those in the older age groups may even benefit from cheaper alcohol in terms of decreased rates of CVD mortality. The results also suggest that reductions in alcohol prices do not necessarily affect interpersonal violence. The population group differences in the effects of the price changes on alcohol-related harm should be acknowledged, and therefore the policy actions should focus on the population subgroups that are primarily responsive to the price reduction.

Mass spectrometry and n-in-one analytics in early drug discovery: Combinatorial chemistry libraries, lipophilicity and absorption screening

This thesis describes current and past n-in-one methods and presents three early experimental studies using mass spectrometry and the triple quadrupole instrument on the application of n-in-one in drug discovery. N-in-one strategy pools and mix samples in drug discovery prior to measurement or analysis. This allows the most promising compounds to be rapidly identified and then analysed. Nowadays properties of drugs are characterised earlier and in parallel with pharmacological efficacy. Studies presented here use in vitro methods as caco-2 cells and immobilized artificial membrane chromatography for drug absorption and lipophilicity measurements. The high sensitivity and selectivity of liquid chromatography mass spectrometry are especially important for new analytical methods using n-in-one. In the first study, the fragmentation patterns of ten nitrophenoxy benzoate compounds, serial homology, were characterised and the presence of the compounds was determined in a combinatorial library. The influence of one or two nitro substituents and the alkyl chain length of methyl to pentyl on collision-induced fragmentation was studied, and interesting structurefragmentation relationships were detected. Two nitro group compounds increased fragmentation compared to one nitro group, whereas less fragmentation was noted in molecules with a longer alkyl chain. The most abundant product ions were nitrophenoxy ions, which were also tested in the precursor ion screening of the combinatorial library. In the second study, the immobilized artificial membrane chromatographic method was transferred from ultraviolet detection to mass spectrometric analysis and a new method was developed. Mass spectra were scanned and the chromatographic retention of compounds was analysed using extract ion chromatograms. When changing detectors and buffers and including n-in-one in the method, the results showed good correlation. Finally, the results demonstrated that mass spectrometric detection with gradient elution can provide a rapid and convenient n-in-one method for ranking the lipophilic properties of several structurally diverse compounds simultaneously. In the final study, a new method was developed for caco-2 samples. Compounds were separated by liquid chromatography and quantified by selected reaction monitoring using mass spectrometry. This method was used for caco-2 samples, where absorption of ten chemically and physiologically different compounds was screened using both single and nin- one approaches. These three studies used mass spectrometry for compound identification, method transfer and quantitation in the area of mixture analysis. Different mass spectrometric scanning modes for the triple quadrupole instrument were used in each method. Early drug discovery with n-in-one is area where mass spectrometric analysis, its possibilities and proper use, is especially important.

Short-term Price Behavior and the Effect of Foreign Investors in Finnish Equity Markets (summary section only)

As globalization and capital free movement has increased, so has interest in the effects of that global money flow, especially during financial crises. The concern has been that large global money flows will affect the pricing of small local markets by causing, in particular, overreaction. The purpose of this thesis is to contribute to the body of work concerning short-term under- and overreaction and the short-term effects of foreign investment flow in the small Finnish equity markets. This thesis also compares foreign execution return to domestic execution return. This study’s results indicate that short-term under- and overreaction occurs in domestic-buy portfolios (domestic net buying) rather than in foreign-buy portfolios. This under- and overreaction, however, is not economically meaningful after controlling for the bid-ask bounce effect. Based on this finding, one can conclude that foreign investors do not have a destabilizing effect in the short-term in the Finnish markets. Foreign activity affects short-term returns. When foreign investors are net buyers (sellers) there are positive (negative) market adjusted returns. Literature related to nationality and institutional effect leads us to expect these kind of results. These foreign flows are persistent at a 5 % to 21 % level and the persistence of foreign buy flow is higher than the foreign sell flow. Foreign daily trading execution is worse than domestic execution. Literature which quantifies foreign investors as liquidity demanders and literature related to front-running leads us to expect poorer foreign execution than domestic execution.

Price Inflation, Unemployment and Devaluations: The Finnish Experience of the 1990s

In this paper I provide some empirical answers to important questions such as the determinants of price inflation and the role of inflation polices. The results indicate that monetary policy is surprisingly impotent as a device for controlling inflation and there is little support that it influences the real variables. The low inflation after the Finnish devaluations in the beginning of 90s is foremost due to a previous imbalance in the labor markets and depressed aggregate demand.

Monetary Policy, Stock Price Misalignments and Macroeconomic Instability

Perhaps the most fundamental prediction of financial theory is that the expected returns on financial assets are determined by the amount of risk contained in their payoffs. Assets with a riskier payoff pattern should provide higher expected returns than assets that are otherwise similar but provide payoffs that contain less risk. Financial theory also predicts that not all types of risks should be compensated with higher expected returns. It is well-known that the asset-specific risk can be diversified away, whereas the systematic component of risk that affects all assets remains even in large portfolios. Thus, the asset-specific risk that the investor can easily get rid of by diversification should not lead to higher expected returns, and only the shared movement of individual asset returns – the sensitivity of these assets to a set of systematic risk factors – should matter for asset pricing. It is within this framework that this thesis is situated. The first essay proposes a new systematic risk factor, hypothesized to be correlated with changes in investor risk aversion, which manages to explain a large fraction of the return variation in the cross-section of stock returns. The second and third essays investigate the pricing of asset-specific risk, uncorrelated with commonly used risk factors, in the cross-section of stock returns. The three essays mentioned above use stock market data from the U.S. The fourth essay presents a new total return stock market index for the Finnish stock market beginning from the opening of the Helsinki Stock Exchange in 1912 and ending in 1969 when other total return indices become available. Because a total return stock market index for the period prior to 1970 has not been available before, academics and stock market participants have not known the historical return that stock market investors in Finland could have achieved on their investments. The new stock market index presented in essay 4 makes it possible, for the first time, to calculate the historical average return on the Finnish stock market and to conduct further studies that require long time-series of data.