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Can strategic market making explain asset pricing? A microstructure analysis of the treasury bond market

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How much asset volume and volatility can be explained in terms of dealers' strategic interaction and through which channel does this effect take place? In the present paper the authors address these issues by using a unique dataset on the Treasury bond market. By identifying dealers in terms of their reaction to the informational content of trade, they show that the same type of trade, on the same asset, in the same market, can generate different volume and volatility patterns, depending on the type of the dealers who are intermediating. They identify the "marginal traders" as the class of dealers that affects market conditions. The authors show that the marginal traders who have the greatest impact in the short run differ from those who have the greatest impact in the long run. They also show that the class of marginal traders is never the largest, nor does it generate the highest volume of trade. They demonstrate that it is not the trade per se that generates volatility, but the informed trade of a particular class of agents. The authors argue that these results have strong implications in terms of forecast ability of future returns and volatility, by showing that most of the explanatory power of trades is due to the marginal traders.

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en

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application/pdf

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http://flora.insead.edu/fichiersti_wp/inseadwp2000/2000-40.pdf

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