Research from the Department of Economics and Business Economics at Aarhus BSS - Aarhus University introduces new methods that allow for a more precise measurement and management of financial risk. The methods apply to high-frequency financial data and allow for a better study of how the markets actually work and how they are organised.
04.06.2020 | FILIP GRAUGAARD ESMARCH og INGRID FOSSUM
High-frequency financial data are huge data sets, which include all completed transactions as well as current bid and offer prices during a day of trading. By using these data, former PhD fellow in economics Martin Thyrsgaard from Aarhus BSS has grappled with the accepted standards within market structure research. His research has led him to a postdoc position at the recognised Northwestern University in Chicago, the US, and his PhD dissertation has just received a PhD award from the Aarhus University Research Foundation.
At the turn of the millennium, research in this field took a quantum leap as researchers now had access to this type of data relevant to the measurement and management of financial risk. However, another important aspect is to find out how the markets actually work and thus how you organise them appropriately.
“How does the very organisation of the financial markets affect the dynamic development of prices and risks during a day of trading? And how does it affect the way in which different players are acting?” These are they key questions summing up Thyrsgaard’s research.
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Uncovering the weknesses
Thyrsgaard has designed a method for statistically testing how well the established models for calculating specific forms of uncertainty in the financial markets actually fit with developments and trends. The older models were known to have their weaknesses, but Thyrsgaard’s research demonstrates why they did not work.
The results, which are based on highly complicated mathematical evidence derived by Martin Thyrsgaard, have been published in Journal of Econometrics, the top journal in the field. in collaboration with Professor of Economics Kim Christensen and Associate Professor of Economics Bezirgen Veliyev, both from Aarhus BSS.
“It is highly likely that in time, the concept will be incorporated into the systems that financial institutions use in their everyday risk management and when they report to national supervising authorities,” says Professor of Economics Niels Haldrup. He is the head of the Department of Economics and Business Economics at Aarhus BSS where Martin Thyrsgaard is still employed as an international fellow.
"Our paper is a step on the way towards understanding the impact of the stock exchanges’ opening and closing hours on the risk development throughout the day."
Martin Thyrsgaard, postdoc Kelloggs School of Management, Northwestern University and fellow, Department of Economics and Business Economics, Aarhus BSS
Stock exchange opening hours make a difference
Thyrsgaard is also studying the notion that stock prices fluctuate in a highly systematic manner throughout the financial market trading day. Significant stock price fluctuations occur right after the stock market opens, smaller fluctuations are seen around lunchtime with fluctuations increasing just before closing time. Combined, they form a U-shape. Traditionally, it has been assumed that this U is constant over time, but Thyrsgaard has developed a method that allows you to test whether this is actually the case. It turns out that the hypothesis does not apply in practice.
Thyrsgaard has published this research in collaboration with Professor Torben G. Andersen, a mathematical economist from Aarhus University and one of the founders of the high-frequency financial data literature, and Professor Viktor Todorov from Northwestern University in Chicago. The research was published in the top statistics journal, Journal of the American Statistical Association.
“Our paper is a step on the way towards understanding the impact of the stock exchanges’ opening and closing hours on the risk development throughout the day. Traditionally, it has been assumed that the relative uncertainty surrounding a stock price at any given time of the day should be the same across the trading days. You would like to be able to have such a pattern available when studying how a particular announcement from the central bank affects the uncertainty. But our statistical tests show that it is not that simple, because the pattern is actually not constant from day to day,” says Thyrsgaard.
High-frequency traders affect stock price
Thyrsgaard is also exploring how the use of computer-based trading methods and their algorithms change during the day. This allows for a more precise price on a stock traded on several stock exchanges.
“My research shows that computer-driven high-frequency traders are fairly active transferring information from one stock exchange to another. Thus they play a key part in balancing the price of a stock traded on several stock exchanges. And they actually become more and more active over the course of a trading day as they become more confident in terms of how prices are developing on that particular day,” he says.
In the wake of the financial crisis, these traders have been subject to a great deal of (often negative) press coverage, and few researchers have studied their so-called cross market trading activity. Thyrsgaard’s research thus provides a framework for an improved analysis of the role these actors play in connection with e.g. extreme price fluctuation.
Facts on the research:
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