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The Dynamics of Price Discovery

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  • Bingcheng Yan
  • Eric Zivot
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    Abstract

    In this paper we propose a new approach for the econometric analysis of the dynamics of price discovery using a structural cointegration model for the price changes in arbitrage linked markets. Our methodology characterizes the dynamics of price discovery based on the impulse response functions from an identified structural cointegration model, and we measure the efficiency of a market’s price discovery by the absolute magnitude of cumulative pricing errors in the price discovery process. We apply our methodology to investigate the extent to which the US dollar contributes to the price discovery of the yen/euro exchange rate. Our results show that substantial price discovery of JPY/EUR occurs through the dollar, and that the efficiency of the dollar’s price discovery is positively related to the relative liquidity of the dollar markets versus the cross rate market.

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    File URL: http://faculty.washington.edu/ezivot/research/structuralanalysispricediscovery20041018.pdf
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    Bibliographic Info

    Paper provided by University of Washington, Department of Economics in its series Working Papers with number UWEC-2005-01-R.

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    Date of creation: Mar 2007
    Date of revision: Mar 2007
    Handle: RePEc:udb:wpaper:uwec-2005-01-r

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    Cited by:
    1. Isabel Figuerola-Ferretti & Jesus Gonzalo, 2007. "Modelling and measuring price discovery in commodity markets," Business Economics Working Papers wb074510, Universidad Carlos III, Departamento de Economía de la Empresa.
    2. Arce, Oscar & Mayordomo, Sergio & Peña, Juan Ignacio, 2013. "Credit-risk valuation in the sovereign CDS and bonds markets: Evidence from the euro area crisis," Journal of International Money and Finance, Elsevier, vol. 35(C), pages 124-145.
    3. Guglielmo Maria Caporale & Alessandro Girardi, 2011. "Price Discovery and Trade Fragmentation in a Multi-Market Environment: Evidence from the MTS System," Discussion Papers of DIW Berlin 1139, DIW Berlin, German Institute for Economic Research.
    4. Kao, Chung-Wei & Wan, Jer-Yuh, 2012. "Price discount, inventories and the distortion of WTI benchmark," Energy Economics, Elsevier, vol. 34(1), pages 117-124.
    5. Otsubo, Yoichi, 2014. "International cross-listing and price discovery under trading concentration in the domestic market: Evidence from Japanese shares," Journal of Empirical Finance, Elsevier, vol. 25(C), pages 36-51.
    6. Wang, Jianxin & Yang, Minxian, 2011. "Housewives of Tokyo versus the gnomes of Zurich: Measuring price discovery in sequential markets," Journal of Financial Markets, Elsevier, vol. 14(1), pages 82-108, February.

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