Essays on Price Discovery.

Abstract

Financial asset prices reflect investor's perspectives over the current and future situation of a firm, an industry, a country and ultimately, the entire economy. For this reason, how financial asset prices are driven has been a fundamental economic question. Specific market characteristics such as the number of sellers and buyers, investors valuation perceptions, market availability of other assets and legal and technical properties are some of the features that affect asset prices. When the same asset is traded at different venues, these specific characteristics may vary, following a certain degree of heterogeneity across buyers and sellers. The direct consequence is that transaction prices of the same asset differ across markets. However, prices will also not drift apart, since arbitrage opportunities would arise, reducing or even eliminating the differences. Prices of similar securities linked to a single latent price, as derivative markets, for instance, present the same behaviour. Price differences among markets observed at high frequencies are an indication that venues incorporate new information in an unlike way. The structure and design of a market impacts its behaviour, liquidity, effciency, and hence how prices are discovered. The task of identifying the leading markets and understanding how the price dynamics occurs are the main objectives of the price discovery analysis. Chapter 1 introduces the research subject of price discovery, motivating the importance of what this thesis proposes and the results and conclusions obtained. Chapter 2 explains in details the main methodologies used to measure price discovery and the important results in the empirical literature. Chapter 3 motivates the data set this thesis uses, with institutional background details and specific market and firm characteristics. We also present in details the steps we follow to deal with standard issues of high frequency data, such as outliers and errors on a tick-by-tick database and non synchronicity of prices at different markets. Chapter 4 extends the standard price discovery model to estimate the information share (IS) accounting for the information content of both common and preferred non US stocks, their American Depositary Receipts (ADRs) counterparts traded on the New York Stock Exchange and ARCA, and the exchange rate. We gauge the significance of price discovery in the home and foreign markets, through common or preferred stocks. One of the main critiques on the IS methodology is that it does not deliver a single measure when there is contemporaneous correlation among markets. We propose an ordering invariant methodology that delivers a single measure of IS.We find that the foreign market is more important than the home market for the price discovery of Petrobras, the Brazilian stated-owned oil giant, and Vale, one of the largest mining companies in the world. Additionally, the Brazilian market has lost significant importance after the 2008/2009 financial crisis. During this period, common and preferred stocks shared a single common factor, with voting premium being a stationary process. Chapter 5 investigates instantaneous and long-run linkages between common and preferred shares traded at both domestic and foreign markets. We develop a market microstructure model in which the dynamics of the different share prices react to three common factors, namely, the efficient price, the efficient exchange rate, and the efficient voting premium. We show how to identify the structural innovations so as to differentiate instantaneous and long-run effects. First, we obtain dynamic measures of price discovery that quantify how prices traded at different venues respond to shocks on the common factors. Second, we are able to test whether shocks in the efficient exchange rate change the value of the firm. Third, we test whether shocks on the efficient voting premium have a permanent effect on preferred shares. We implement an empirical application using high-frequency data on six Brazilian large companies. We find that, in the long-run, a depreciation of the Brazilian currency leads to a depreciation of the value of the firm that exceeds the expected arbitrage adjustment. In addition, a positive shock on the voting premium yields a positive impact on the value of the firm. Our price discovery analysis also reveals that one trading day suffices to impound new information on all share prices, regardless of the venue they trade at. Finally, Chapter 6 concludes.