Price Discovery in Illiquid Market

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Price Discovery in Illiquid markets: Do Financial Asset Prices Rise Faster Than They Fall?| |
Submitted by:Dinesh MaharjanMBAe-Trimester VIG-one|

Richard C.. Green, Dan Li and Norman schurhoff. Price discovery in illiquid market: Do financial asset prices rises faster than they fall. The journal of Finance. VOL LXV, No.5, OCTOBER 2010| Submitted To:

Kiran Thapa
Portfolio Management and Security Analysis
(Course instructor)
Ace Institute of Management

I. Introduction
In OTC bond markets many investors face high costs of trade, and these costs appear to be related to the lack of price transparency. This journal studies the consequences this has for efficient price discovery. In the municipal bond market, unlike the markets for most consumer goods, dealers trade with retail customers as both buyers and sellers and as in consumer markets, in municipal bond market prices appear to “rise faster than they fall. This asymmetric price adjustment, referred to as “rockets and feather”, is generally understood by economists to be inconsistent with perfect completion between sellers. Sellers appear to exploit local market power due to the search cost of information that customers face and opportunistically delay the recognition of price movements in dealing with customers The report reflects the asymmetric price adjustment in a major OTC financial market using a comprehensive sample of all trades in municipal bonds over a 5- year period. The report focuses on how the dealers take advantage through manipulation of bond price. On average dealers are “buying wholesale” and “selling retail”, the asymmetric movement in prices benefits dealers. II. Objectives of Study

* The main purpose of this paper is to study the price discovery in municipal bond. * To analyze How and why the price of the municipal bond rise faster than they fall (rockets and feathers) i.e. asymmetric price adjustment * Study the cross-section behavior of bond price with regard to macroeconomic news, treasury yield and how dealers exploit the opportunity of price asymmetry. * To study behavior of intermediaries with respect to price movement, bid-ask spread III. Literature Review

Green, Hollifield, and Schurhoff (2007b) show that that newly issued bonds exhibit some peculiar behaviors and high levels of price dispersion. As shown in Green, Hollifield, and Schurhoff (2007a), dealer purchase from and sales to customers are roughly in same value. There are a large number of bounds outstanding, but most individual bonds trade infrequently; intraday price variation can be large compared to movements in fundamentals (Green, Hollifield, and Schurhoff). Hence this paper employs only panel data methods and focus on transactions data aggregated at a daily frequency. Studies on the treasury market generally find that price react almost instantaneously to surprises in scheduled macroeconomic announcements, that the announcements trigger abnormally high volume, and that there is little autocorrelation in returns after the first minute (Ederington and Lee ( 1993, 1995), Fleming and Remolona (1999), and Balduzzi, Elton, and Green (2001), Piazzesi (2005) studies the price reaction to the FOMC meeting statements and finds that the price response to surprises in these announcements is more sluggish, perhaps because of the qualitative nature of the announcements and their unexpected timing. Harris and Piwowar (2006) and Green, Hollifield and Schurhoff (2007a), investigate the cross-section determinants of dealer trading profits, but whether markups differ when prices are rising versus falling. If prices rise faster than they fall, as in markets for retail goods, then the markup should increase during market rallies by more than if it falls when prices are decreasing. Search costs have been used to explain price dispersion in OTC markets and hidden costs in financial services. Carlin (2009) describes how opacity...
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