The Study Of Market Resiliency

The study of market liquidity is always a main topic for academic researchers and practitioners.It is important for traders,regulators.The liquidity counts a lot in the execution of trading strategies.In practice,we find that liquidity has a big influence on transaction costs.When a trader detects a momentum,other momentum traders always are entering the market at the same time,thus takes out the liquidity at the other side.momentum traders have to get higher costs while competing other traders with higher speed.they have to give up if the liquidity at the other side are run out,or reenter the market when liquidity replenishment occurs.As for reverse traders,when traders on the other side are taking liquidity again and again,indicating that they can pay more costs to get in the market.Reverse traders can offer higher price and wait traders to find them and trade,because at this time the liquidity they are holding is scarce.The cost payed by traders on the other side is reverse traders’ profit.Reverse traders must be aware of liquidity conditions of both their side and the traders on the other side. If reverse traders are competing to offer liquidity, they must make aggressive orders.Big traders,like hedgers,are always playing roles as both liquidity takers and providers.The main question they are facing with is how to develop optimal trading strategies,when there is a liquidity shock,how fast pricing errors are vanished,how fast the spread,market depth and volatility recover to former level and what characters the market resilience have.With these questions,we start from the trading mechanism in the future market,and then describe the source and dimension of liquidity,making deeper analysis in market resilience.The liquidity is a multi-dimentional concept, as a result of design of market trading mechanism. Market has two types of trading sessions:call markets and continuous markets.In call markets,all traders trade at the same time when market is called.In continuous markets,traders may trade anytime the market is open.Market has three types of execution systems:quote-driven dealer markets,order-driven markets and brokered markets.In quote-driven dealer markets,dealers participate in every trade.Dealers act as market makers,anyone who wants to trade must trade with a dealer.Dealers offer all liquidity to all traders.In order-driven markets,buyers and sellers regularly trade with each other without the intermediation of dealers.In this market,traders can offer or take liquidity.Traders who offer liquidity indicate the terms at which they trade.Traders who take liquidity accept those terms.In brokered markets,brokers actively search liquidity to match buyers and sellers.As Shanghai Futures Exchange,Dalian Commodity Exchange,Zhengzhou Commodity Exchange and China Financial Futures Exchange are all continuous order-driven markets,unlike ECNs in USA or other decentralized trading markets,if liquidity providers,who are traders who submit limit orders in limit order book,cannot satisfy liquidity takers’ demands,a shock may take existence in limit order book,thus making price uninformative. Then value traders,market makers and arbitrageurs participant in,force price to return to former level.The question here is:how fast are these pricing errors eliminated through the competitive actions of value traders, dealers and others market participants.So in this paper,we investigate the main features of resiliency as a dimention of liquidity.First,from the view of price discovery process,we developed a pricing error stochastic process based on Ornstein-Uhlenbeck model.Then we reduced Jim Gatheral’s (2008) price impact model and got a same pricing error process.Our findings show that in13futures products, most products have higher resiliency in5s sample,and frequently traded future contracts (dominant contracts) have higher probabilities that pricing errors are corrected.Besides,we conducted a vector-autoregression model to investigate the dynamic behaviors among market depth in each side, spread and volatility. Our findings show that in all samples,frequently traded future contracts have higher resiliency.Almost all contracts’ prices returned to long-term equilibrium after a large shock on market depth in each side,within12periods.However, second frequently traded future contracts’ pricing errors have long-memory effects.We also find that shocks on market depth of the best bid have lower resiliency than the ask side of Index-Future Contracts..