Financial Markets with Multidimensional Uncertainty
Learning About Toxicity: Why Order Imbalance Can Destabilize Markets with X. He and T. Putnins
Abstract: How does a market digest order imbalance? We show that when market participants learn about the level of adverse selection (the risk of trading against better-informed counterparties) from order flow, a large order imbalance can be destabilizing, causing sharp price movements and evaporation of liquidity, as it signals high toxicity. While such effect is consistent with the practitioner view that order flow is informative about toxicity, it contrasts with standard microstructure models in which the level of adverse selection is assumed to be known and thus order imbalance improves liquidity by revealing private information. Our model helps to understand when markets are most susceptible to imbalance-induced instability and the dynamic process of how markets digest order imbalance.
The Pricing Effects of Composition Uncertainty
Abstract: The "quant crisis" of 2007 and subsequent unfolding of the global financial crisis highlighted the importance of the "crowded-trade" problem (not being able to know how many others are taking the same position). To investigate the crowded trading, we present a model in which informed and uninformed traders face uncertainty about the composition of traders (composition uncertainty). We characterize the equilibrium in both the information and financial markets. Composition uncertainty distorts traders' information acquisition, demands, and perceived equity premium, resulting in a security price mispricing. The model helps to understand a linkage between liquidity and asset prices, proposes plausible explanations for large price swings, and demonstrates how current regulations to enhance market efficiency may not work in the presence of composition uncertainty.
Ambiguous Price Formation with X. He
Abstract: Markets often experience liquidity deteriorations during financial crisis and improvements during reforms in trading rules. To explain these phenomena, we present a price formation model in which market makers are subject to ambiguity. When the market maker is sufficiently ambiguity averse, the illiquidity naturally arises in ambiguous market episodes due to the increased perceived adverse selection risk. Ambiguity can also improve liquidity when the market maker is insufficiently ambiguity averse. Consequently, the liquidity improvements can increase the value of information to informed traders and welfare to society. Furthermore, the presence of ambiguity leads the informed traders to trade large quantities.
Toward A General Model of Financial Markets with Xue-Zhong He
Abstract: This paper discusses the efficient market hypothesis and behavioral finance under a general framework using the literature of decision theories and information sciences. The focus is centered on the broad definition of subjective rationality, the imprecision, and reliability of information. The main thesis advanced is that the roots of behavioral anomalies are the imprecision and reliability of information. We show that the proposed general framework is useful to understand economic/financial puzzles consistently. We exemplify insurance and gambling, and equity premium puzzles for this purpose. We also present a possible fuzzy representation of market efficiency.
Tradr White Paper
Abstract: The fragmentation of music rights has created a structurally inefficient market for licensing music. Tradr unites the industry by creating the world’s first transparent source of truth for music rights, available for free to any licensee, based on predetermined permissions set by rights holders. This platform enables an automated and highly efficient system of rights exchange, minimising licensee costs and maximising right holder monetization opportunities, including artist commoditization and rights financing. Tradr allows rights holders to maintain complete autonomy of their music, providing a significant value shift for the many millions of independent artists and creators and the music industry as a whole. To represent the value of Tradr, we design a cryptographically secure token that stimulates network size and coordination between network participants.
Latest draft available (Github)
Enosi Green Paper
Abstract: Modern energy markets are structurally inefficient, resulting in expensive electricity prices for consumers. The Enosi project aims to eliminate these structural inefficiencies by enabling new businesses and not-for-profit entities to compete with incumbent energy companies. To achieve such an ecosystem, Enosi has developed a novel distributed ledger software platform with standardised energy market logic to create efficient networks of interconnected participants. This platform sets the incumbents (Licensed Retail Suppliers) and new Enosi participants (Neo-Retailers) on a level playing field within the market by fostering both cooperation and competition among the system participants. To represent the value of the Enosi network, we define a fungible cryptographically-secure token, the Joul, with an objective to encourage cohesion of the network.