Secrets of Finances and Payday Loans

The loan spread will revert to its former level

admin — Sat, 15 May 2010 14:46:16 +0000

Foucault, Kadan and Kandel (2005) develop a model for a limit order market where there are only strategic liquidity traders and the choice between limit and market orders depends only on their degree of impatience. This model focuses on one of the dimensions of liquidity, namely immediacy. Traders who want to trade as soon as possible demand immediacy. This is an important feature of liquidity, insofar as traders value execution speed differently. Hence this model emphasizes the dual role of limit order books as markets where agents can demand and/or supply immediacy. Agents demand immediacy when they submit market orders and they supply immediacy when they post limit orders. Foucault, Kadan and Kandel show that in equilibrium patient traders tend to submit limit orders and impatient traders, market orders. The two key determinants of the limit order dynamics are the ratio of patient to impatient traders and their respective order arrival rates. Further, under several simplifying assumptions, the model derives the expected time to execution for limit orders, the stationary probability distribution of the spread and the expected interval between trades. Hence the model can measure market resiliency by the probability that, after a liquidity shock, the spread will revert to its former level.

A trader faces credit influencede by his estimates

admin — Fri, 16 Apr 2010 20:38:04 +0000

As mentioned above, the choice each trader faces between market orders and limit orders is influenced by his estimate of the probability of execution, which depends both on the depth of the book at the time of the order submission and on the number of orders that may arrive over the remainder of the day. All traders coming to the marketplace take this updating process into account and in equilibrium the traders’ behaviour generates systematic patterns in transaction prices and order placement strategies. The results from this model show that both sides of the book affect agents’ order placing strategies, and enable us to explain some of the well-known price patterns established, for instance, by Biais, Hillion and Spatt.

The loan spread due to order processing costs

admin — Mon, 15 Mar 2010 09:36:59 +0000

Parlour’s (1998) model considers the choice between market and limit orders to show the working of a limit order book. In her simplified world there are only strategic risk-neutral liquidity traders who are endowed with a different evaluation of the risky asset and arrive randomly at the market to submit either a market order (MO) or a limit order (LO). The novelty of this model is precisely the choice of the type of order to submit. As will be clarified below, this is not a model of price formation, since it assumes an exogenously given bid–ask spread at which traders can submit their orders; however, it introduces the strategic interaction between traders and the state of the limit order book, which is an important element previously disregarded by the literature on the functioning of an LOB. Furthermore, this model does not consider asymmetric information on the fundamental value of the asset; since traders are endowed only with their personal evaluation of the asset, they cannot exploit any information on its future value; it follows that in this model there are no adverse selection costs, nor are there inventory costs, since there are no market-makers offering liquidity. The spread is simply due to order processing costs.

Loan prices take continuous values

admin — Sun, 14 Feb 2010 23:30:59 +0000

In the rest of this blog three models will be outlined in which the choice between limit and market orders is the key element of traders’ optimization strategies. The model by Parlour (1998) concentrates on the time priority rule, which governs limit order books, and shows how the choice between market and limit orders depends crucially on the state of both sides of the book at the time the order is submitted. Foucault’s (1999) model of price formation focuses instead on the winner’s curse problem, which arises when limit order submitters cannot cancel their orders and, due to the arrival of public information, run the risk of being picked off by incoming traders submitting market orders. In the model by Foucault, Kadan and Kandel (2005) the determinants of the price formation process and of the strategic order submission choice are instead the speed of agents’ arrival on the market, their waiting costs and the relative number of patient and impatient traders. Although the work is not presented in this chapter, the reader should be aware that Rosu (2004) extends the Foucault, Kadan and Kandel model by allowing both limit order traders to cancel their orders and prices to take continuous values.

Payday loans and equity market performance

admin — Fri, 30 Oct 2009 22:13:33 +0000

The high correlation between M&A activity and equity market performance clearly shows that M&A was a major driver of the equity bubble of the late 1990s. Sometimes even mergers that did not create synergies were rewarded by rising stock prices on the side of the overtaking parties. It was obvious that not every merger was going to increase operating profitability.

Yet, the degrees of freedom in goodwill accounting helped to grow earnings per share without actually increasing profit levels. At the height of the equity bubble, investors encouraged companies to use their own overvalued equity to pay for the overvalued assets of another company.

Reasons that explain the credit spread differential

admin — Thu, 29 Oct 2009 20:03:08 +0000

But the more cyclical character of the US market and the lower average credit quality of the issuers are not the only reasons that explain the spread differential. Another reason is the different investor base. It was already pointed out that the European corporate bond market is still young, while the US market is well developed and has attracted a broad base of institutional investors. Those investors are usually very concerned about markto-market losses, and therefore their decisions are driven by short-term considerations. Furthermore, hedge funds have been very active in the US corporate bond market over the last years. Both issues have helped to increase volatility. However, with the growing liquidity of the European corporate bond market and the increased professionality of investors, this differential probably will diminish.

The average credit quality of the issuers

admin — Wed, 28 Oct 2009 19:59:01 +0000

From the industry structure it becomes obvious that the average credit quality of the issuers in the US investment grade market is lower than in the Euro corporate bond market. The current rating of the Euro market is A, whereas it is only A_ in the US market. Over the last 5 years this differential has fluctuated between 1 and 2 notches. This helps to explain the wider spreads generally observed in the US corporate bond market. Additionally, US corporate bond spreads have been substantially more volatile than their Euro peers. Especially in times of weak equity markets and rising implied equity volatility the US market tends to underperform.

This is due to the fact that lower rated bonds are usually closer to the default threshold. Therefore, the put option on the assets of the company is more sensitive to changes in equity price and volatility.

Changes in the payday interest-rate environment

admin — Tue, 27 Oct 2009 18:42:35 +0000

A comparison of the sector structure of the Euro and US dollar corporate bond markets shows that the share of financials is much higher in the Euro market. While financial companies are somewhat cyclical, especially with respect to changes in the interest-rate environment, they are usually considered a rather defensive sector. The same holds true for the utility sector. Thus, it becomes very clear that the Euro corporate bond market as a whole is less exposed to the economic environment than the US market. However, we have not analyzed the industrial sector so far. Here, the picture is mixed. While the Euro market has a higher weight of automotive companies, the other cyclical sectors, such as basic industries, capital goods, consumer and services cyclical, media and technology, generally have a higher share in the US market.

The structure and assessment of loans market

admin — Mon, 26 Oct 2009 17:36:23 +0000

The assessment of the macroeconomic environment results in a judgement of the stage of the business cycle and the leverage cycle. Valuation indicators help to form an opinion on the future direction of credit spreads. However, the magnitude of a change in spreads essentially depends on the market structure, especially the average credit quality and the share of cyclical sectors. Lower average quality of the issues or a higher portion of cyclical industries typically results in a higher volatility of credit spreads, and therefore higher mark-to-market risk. Rational investors should require an additional risk premium for investing in a more volatile market, as an additional spread provides a cushion against adverse market movements.

Utility-maximizing behavior of real estate investors

admin — Sun, 25 Oct 2009 16:14:07 +0000

Tversky and Kahneman and Shiller argue that the assumption of rational, utility-maximizing behavior of investors is frequently violated in real life. They also show that these anomalies can be predicted and that they result from the use of simple heuristics to facilitate the process of decision-making. Sophisticated investors can benefit from this fact if they are able to predict changes in the direction of risk appetite correctly. In particular, reversals in risk appetite often correspond with turning points in the direction of spreads. Risk appetite indicators may also be a useful tool for major asset allocation decisions such as stocks versus bonds, value versus growth stocks or emerging markets versus developed markets.