Financial Markets and Trading – An Introduction to Market Microstructure and Trading Strategies

Preface ix
<p>Acknowledgments xiii</p>
<p>PART ONE<br /> Market Microstructure 1</p>
<p>CHAPTER 1<br /> Financial Markets: Traders, Orders, and Systems 3</p>
<p>Traders 3</p>
<p>Orders 5</p>
<p>The Bid/Ask Spread 7</p>
<p>Liquidity 9</p>
<p>Market Structures 9</p>
<p>Continuous Order–Driven Markets 10</p>
<p>Oral Auctions 11</p>
<p>Call Auctions 12</p>
<p>Quote–Driven Markets and Hybrid Markets 13</p>
<p>CHAPTER 2<br /> Modern Financial Markets 15</p>
<p>The U.S. Equity Markets 15</p>
<p>The NYSE 15</p>
<p>NASDAQ 16</p>
<p>Alternative Trading Systems 17</p>
<p>European Equity Markets 18</p>
<p>Spot FX Market 19</p>
<p>The U.S. Fixed Income Markets 21</p>
<p>High–Frequency Trading 22</p>
<p>CHAPTER 3<br /> Inventory Models 26</p>
<p>Risk–Neutral Models 26</p>
<p>The Garman s Model 26</p>
<p>Amihud–Mendelson Model 29</p>
<p>Models with Risk Aversion 29</p>
<p>What Is Risk Aversion? 29</p>
<p>The Stoll s Model 31</p>
<p>CHAPTER 4<br /> Market Microstructure: Information–Based Models 35</p>
<p>Kyle s Model 35</p>
<p>One–Period Model 35</p>
<p>Multi–Period and Multi–Insider Models 38</p>
<p>Glosten–Milgrom Model 39</p>
<p>Further Developments 41</p>
<p>CHAPTER 5<br /> Models of the Limit–Order Markets 44</p>
<p>The CMSW Model 44</p>
<p>The Parlour Model 46</p>
<p>The Foucault Model 47</p>
<p>Equilibrium at Zero Volatility 48</p>
<p>Volatility Effect 49</p>
<p>New Developments 50</p>
<p>CHAPTER 6<br /> Empirical Market Microstructure 53</p>
<p>Roll s Model 53</p>
<p>The Glosten–Harris Model 55</p>
<p>Structural Models 56</p>
<p>Recent Empirical Findings 58</p>
<p>Equity Markets 58</p>
<p>Global FX Spot Market 60</p>
<p>PART TWO<br /> Market Dynamics 63</p>
<p>CHAPTER 7<br /> Statistical Distributions and Dynamics of Returns 65</p>
<p>Prices and Returns 65</p>
<p>The Efficient Market Hypothesis 66</p>
<p>Random Walk and Predictability of Returns 68</p>
<p>Recent Empirical Findings 69</p>
<p>Fractals in Finance 72</p>
<p>CHAPTER 8<br /> Volatility 75</p>
<p>Basic Notions 75</p>
<p>Conditional Heteroskedasticity 77</p>
<p>Realized Volatility 79</p>
<p>Market Risk Measurement 81</p>
<p>CHAPTER 9<br /> Agent–Based Modeling of Financial Markets 86</p>
<p>Adaptive Equilibrium Models 87</p>
<p>Non–Equilibrium Price Models 89</p>
<p>The Observable–Variables Model 91</p>
<p>Modeling Efficiency of Technical Trading 94</p>
<p>Modeling the Birth of a Two–Sided Market 95</p>
<p>PART THREE<br /> Trading Strategies 101</p>
<p>CHAPTER 10<br /> Technical Trading Strategies 103</p>
<p>Trend Strategies 105</p>
<p>Filter Rules 105</p>
<p>Moving–Average Rules 106</p>
<p>Channel Breakouts 107</p>
<p>Momentum and Oscillator Strategies 109</p>
<p>Complex Geometric Patterns 113</p>
<p>CHAPTER 11<br /> Arbitrage Trading Strategies 117</p>
<p>Hedging Strategies 118</p>
<p>Pair Trading 120</p>
<p>Cointegration and Causality 121</p>
<p>Pair Selection 123</p>
<p>Arbitrage Risks 125</p>
<p>CHAPTER 12<br /> Back–Testing of Trading Strategies 129</p>
<p>Performance Measures 131</p>
<p>Resampling Techniques 133</p>
<p>Bootstrap 133</p>
<p>Markov Chain Monte Carlo 135</p>
<p>Random Entry Protocol 136</p>
<p>Comparing Trading Strategies 137</p>
<p>Bootstrap Reality Check 138</p>
<p>New Developments 139</p>
<p>CHAPTER 13<br /> Execution Strategies 142</p>
<p>Benchmark–Driven Schedules 143</p>
<p>Cost–Driven Schedules 145</p>
<p>Risk–Neutral Framework 145</p>
<p>Risk–Averse Framework 147</p>
<p>The Taker s Dilemma 151</p>
<p>The Random Walk Model 153</p>
<p>Simulations of the Execution Costs 154</p>
<p>APPENDIX A<br /> Probability Distributions 156</p>
<p>Basic Notions 156</p>
<p>Frequently Used Distributions 159</p>
<p>The Uniform Distribution 159</p>
<p>The Binomial Distribution 159</p>
<p>The Poisson Distribution 160</p>
<p>The Normal Distribution 160</p>
<p>The Lognormal Distribution 161</p>
<p>The Cauchy Distribution 162</p>
<p>The Gamma Distribution 162</p>
<p>Stable Distributions and Scale Invariance 162</p>
<p>APPENDIX B<br /> Elements of Time Series Analysis 165</p>
<p>The Autoregressive Model 165</p>
<p>The Moving Average Model 167</p>
<p>The ARMA Model 168</p>
<p>Trends and Seasonality 170</p>
<p>Multivariate Time Series 172</p>
<p>Notes 174</p>
<p>References 180</p>
<p>About the Author 190</p>
<p>Index 191</p>