FIRM Project – Management of Market Price Risks: Regulation and Coordination of Volatility Interruptions in Europe
Between October 2015 and March 2018 the Chair of e-Finance works on a research project to systematically analyzing volatility interruptions on European stock markets. The goal of the research project, which is financially supported by the Frankfurt Institute for Risk Management and Regulation, is to examine empirically and experimentally whether volatility interruptions - so called circuit breakers - are adequate mechanisms to reduce extreme price jumps and market price risks on European financial markets.
Due to the increase of extreme price movement over the past years and the high relevance of high frequency trading, market safeguards such as volatility interruptions seem to be necessary to ensure the integrity of securities markets. The research project therefore aims to analyze the effects of different volatility interruption designs on market quality parameters such as volatility, liquidity, or price determination. In addition, the project will deliver knowledge on whether a coordination of volatility interruption is necessary in the course of an increasing fragmentation of the European securities trading landscape.
The results of the empirical analysis highlight that market safeguards in the form of volatility interruption are able to reduce volatility. But this reduction of volatility comes at the cost of reduced liquidity. The configuration of the underlying parameters such as the duration of the volatility interruption or the width of the triggering price thresholds are of superior importance and should be evaluated in detail when calibrating safeguards. Further, the research project provides empirical evidence against the hypothesis that an active volatility interruption on the main market leads to a volume shift and volatility spillover to alternative trading venues.
In summary, the results support regulators and market operators regarding the implementation and recalibration of market safeguards and contribute to the protection of investors and intermediaries against extreme price jumps and market price risks.
Further information on the Frankfurt Institute for Risk Management and Regulation can be found under https://www.firm.fm/start.html.
The Impact of the MiFIR Trading Obligation for Shares on Market Liquidity
In July 2017, the chair of e-Finance started - in cooperation with Deutsche Börse AG - a research project to analyze potential effects of the new requirements of MiFID II and MiFIR, which have to be applied by investment firms, market operators, data reporting service providers, and specific third-country firms from January 3rd, 2018 onwards.
MiFID II / MiFIR will fundamentally change the trading and market landscape in Europe. The new regulation aims to assure a safer, sounder, more transparent, and more responsible financial system. Besides, new rules for OTC (Over the Counter) trading, commodity derivative markets, as well as Algorithmic and High Frequency Trading will apply. A key concept of MiFID II / MiFIR is the organization of trading on regulated venues: Non-equity instruments shall be traded on a new category of trading venues called Organized Trading Facilities (OTF). In addition, a new trading obligation for shares has been introduced which intends to restrict OTC trading. Therefore, the new framework will significantly influence European equities trading and will likely result in a redistribution of market shares between trading venues.
By investigating related literature, developing different simulation scenarios, as well as consulting industry and academic experts, the research project examines three research topics associated with the new regulatory requirements. First, drivers and goals of MiFID II / MiFIR are analyzed against the background of the changes in European share trading. Second, the potential impact of the trading obligation imposed by MiFIR on market share distribution and liquidity is assessed. Finally, the impact on the European market structure as well as the relative importance of different types of trading venues is analyzed.
The results of the research project provide a toolbox for market participants to assess changes in market shares of venues and liquidity based on their own expectations as well as a benchmark for studies analyzing the actual impact of the trading obligation after the regulatory requirements come into effect.