From Theory to Application: Using Simulation to Better Understand Price Determination in a Non-Frictionless Equity Market

35 Pages Posted: 14 Nov 2016

See all articles by Jian Hua

Jian Hua

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance

Robert A. Schwartz

Baruch College - CUNY

Gregory Sipress

TraderEx LLC

Date Written: October 31, 2016

Abstract

This paper focuses on an analytic approach that has received relatively sparse application in the economics/finance literature: simulation. Providing a laboratory-type environment, simulation can generate data that enable a com- plex environment to be assessed in a tractable manner that might not otherwise be readily achievable. These thoughts are illustrated with reference to Grossman and Stiglitz’s (1976) seminal paper on price formation in an equity market. Our simulation results show that, as is not the case in a frictionless market, the dynamic pro- cess of price formation in a non-frictionless market can generate returns that exhibit accentuated short-period volatility, kurtosis, and returns autocorrelations.

Keywords: simulation analysis, stock return distribution, tail thickness, excess kurtosis, mixture of distributions, market structure, call auctions, continuous trading

JEL Classification: G10, G12, C8, C9

Suggested Citation

Hua, Jian and Schwartz, Robert A. and Sipress, Gregory, From Theory to Application: Using Simulation to Better Understand Price Determination in a Non-Frictionless Equity Market (October 31, 2016). Available at SSRN: https://ssrn.com/abstract=2868554 or http://dx.doi.org/10.2139/ssrn.2868554

Jian Hua (Contact Author)

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance ( email )

17 Lexington Avenue
New York, NY 10010
United States

Robert A. Schwartz

Baruch College - CUNY ( email )

Zicklin School of Business
17 Lexington Avenue
New York, NY 10010
United States
646-312-3467 (Phone)
646-312-3530 (Fax)

Gregory Sipress

TraderEx LLC ( email )

New York, NY
United States

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