TY - JOUR

T1 - Trading dynamics in the foreign exchange market

T2 - a latent factor panel intensity approach

AU - Nolte, Ingmar

AU - Voev, Valeri

PY - 2011

Y1 - 2011

N2 - We develop a panel intensity framework for the analysis of complex trading activity datasets containing detailed information on individual trading actions in different securities for a set of investors. A feature of the model is the presence of a time-varying latent factor, which captures the influence of unobserved time effects and allows for correlation across individuals. We contribute to the literature on market microstructure and behavioral finance by providing new results on the disposition effect and on the manifestation of risk aversion on the high-frequency trading level. These novel insights are made possible by the joint characterization of not only the decision to close (exit) a position, usually considered in isolation in the literature, but also the decision to open (enter) a position, which together describe the trading process in its entirety. While the disposition effect is defined with respect to the willingness to realize profits/losses with respect to the performance of the position under consideration, we find that the performance of the total portfolio of positions is an additional factor influencing trading decisions that can reinforce or dampen the standard disposition effect. Moreover, the proposed methodology allows the investigation of the strength of these effects for different groups of investors ranging from small retail investors to professional and institutional investors.

AB - We develop a panel intensity framework for the analysis of complex trading activity datasets containing detailed information on individual trading actions in different securities for a set of investors. A feature of the model is the presence of a time-varying latent factor, which captures the influence of unobserved time effects and allows for correlation across individuals. We contribute to the literature on market microstructure and behavioral finance by providing new results on the disposition effect and on the manifestation of risk aversion on the high-frequency trading level. These novel insights are made possible by the joint characterization of not only the decision to close (exit) a position, usually considered in isolation in the literature, but also the decision to open (enter) a position, which together describe the trading process in its entirety. While the disposition effect is defined with respect to the willingness to realize profits/losses with respect to the performance of the position under consideration, we find that the performance of the total portfolio of positions is an additional factor influencing trading decisions that can reinforce or dampen the standard disposition effect. Moreover, the proposed methodology allows the investigation of the strength of these effects for different groups of investors ranging from small retail investors to professional and institutional investors.

KW - behavioral finance

KW - efficient importance sampling

KW - latent factors

KW - market microstructure

KW - panel intensity models

KW - stochastic conditional intensity

KW - trading activity datasets

U2 - 10.1093/jjfinec/nbq033

DO - 10.1093/jjfinec/nbq033

M3 - Journal article

VL - 9

SP - 685

EP - 716

JO - Journal of Financial Econometrics

JF - Journal of Financial Econometrics

SN - 1479-8409

IS - 4

ER -