6.2 Forms of Historical Market Data
Market data can represent market prices, interest rates, spreads, implied volatilities, etc. Any of these may be directly quoted in the markets, or they may be inferred from other quantities that are directly quoted. All are, in some sense, prices. In this section, we shall use the word “price” expansively to reflect this. Price data can vary with respect to type, method of collection, and source.
6.2.1 Types of prices
There are essentially four types of market data:
- Transaction prices are prices at which actual transactions took place.
- Firm prices are bid or offer prices quoted by market participants, who are then obligated to transact at those prices if accepted by a counterparty. Firm bid and offer prices may be averaged to obtain firm mid-market prices.
- Indicative prices are bid, offer, or mid-market prices quoted by market participants—usually dealers or other market makers—for informational purposes only. The quoting party has no obligation to transact. Indicative prices can also be
- Settlement prices are prices specified by exchanges for the purpose of calculating daily margin requirements. Each exchange has its own rules for calculating settlement prices based upon transaction, firm, or indicative prices.
6.2.2 Collecting Data
Time series of historical market data are constructed by recording prices at a regular interval—each day, each week, each month, etc. For settlement prices, collecting market data is as easy as recording the daily settlement prices released by the appropriate exchange.
Transaction prices are more problematic. For actively traded instruments, there can be thousands of transactions spaced at irregular intervals throughout each day. Other assets trade less frequently and may fail to trade at all on some days. Four approaches for collecting daily market data are:
- opening prices, which comprise the first transaction price following the market open each day;
- closing prices, which comprise the last transaction price prior to the market close each day;
- high prices, which comprise the highest transaction price each day; or
- low prices, which comprise the lowest transaction price each day.
For value-at-risk applications, closing prices are most commonly used. Irrespective of how they are collected, transaction prices tend to be nonsynchronous. This means that prices for different assets will reflect transactions occurring at different times. On a given day, the last trade in one stock might occur at 2:20 PM with the last trade in another occurring at 4:15 PM.
If trading in an asset is light, several days or weeks may transpire between transactions. If there are no transactions in a given day, a missing data indicator may be entered in the time series in lieu of a value. Alternatively, some rule may be applied for filling in missing values. On days when an asset doesn’t trade, its closing price might be set equal to the previous day’s closing price.
With exchanges implementing evening trading sessions and electronic trading sessions, it is important to clarify which trading sessions opening, closing, high, and low prices are based upon. For markets that trade around the clock, such as foreign exchange, the notions of market open and market close are not meaningful. In such cases, two times can be selected to represent “market open” and “market close.” In certain OTC markets, high and low prices may be exaggerated by outliers—transactions at significantly off-market prices. Some rule may be employed to discard outliers when calculating high and low prices.
Firm or indicative prices are easier to collect synchronously than transaction prices. In inactive markets, indicative quotes may be solicited from brokers or dealers at a fixed time each day. In more active markets, firm or indicative quotes are distributed electronically throughout each trading day. Problems may arise during periods of active trading when dealers may be too busy to update indicative quotes. Lyons (1995) observes that, during periods of volatility in the foreign exchange market, indicative bid and offer prices on Reuters FXFX screens sometimes failed to bracket transaction prices.
A shortcoming of indicative quotes is questionable quality. If a relationship exists with the quoting party, that party will want to provide quality quotes. However, market makers have no financial stake in indicative quotes, so they are unlikely to prepare them as carefully as they would firm quotes. A less common problem is indicative quotes being intentionally made off-market as a means of influencing markets. Such behavior was widespread for several years among banks contributing indicative quotes to the British Bankers Association (BBA) for calculating Libor.
The particular types of market data we choose to use in a value-at-risk analysis will depend upon the foregoing issues as well as availability. Transaction prices are generally available for exchange-traded instruments but are more difficult to obtain in OTC markets. Settlement prices are only available for exchange-traded instruments that are margined—primarily futures and options. In some OTC markets, firm quotes may be available. In others, it may only be possible to obtain indicative quotes. Indeed, in many markets, market data of any sort may be difficult to obtain.