I am a Market Structure Fellow at Jain Family Institute or JFI. In this fellowship, I launch a project called Primary Source, which provides a “forward-looking” and “structural” approach toward financial stability. This project surveils “systemic fluidity” and the stability of “market microstructure.” In contrast to systemic risk, systemic fluidity refers to a continuous flow and market fundamentals across an invisible supply chain. It is a characteristic of a resilient market microstructure. Classical financial stability theories concentrate on the ex-post systemic risk, the type that drives system-wide breakdown, or ex-ante predictive indicators. In these models, systemic risks occur, and liquidity indicators fluctuate in a “black box.” This program departs from this classical approach and looks inside the black box.
Specifically, the project surveils the strength of systemic fluidity across four hybrid yet different pipelines: (1) flow of collateral (arises from firms’ industrial organization), (2) flow of risks (arises from engineering and trade mechanisms of derivatives), (3) flow of fund (arises from the hierarchy of funding market), and (4) flow of payments (arises from the system-wide liquidity transformation). Throughout the program, we cut through the noises of market structure to categorize its vulnerabilities as structural, cyclical, and event-driven. The project’s primary source is the financial institutions’ research papers and narratives. The ultimate objective is to build a forward-looking financial stability framework based on the resilience of market microstructure rather than certain activities or entities.
The JFI Market Structure program analyzes an unmapped step in the supply chain of financial stability- the market microstructure’s footprint in systemic risk. This project uses primary sources. In particular, it thoroughly and continuously examines the research output of major financial institutions such as Goldman Sachs, Barclays, Bank of America, J.P. Morgan, and others. In addition, we interview senior researchers in financial firms every month to discuss their work in the context of market structure. The goal is to monitor the financial system’s evolution and examine the implications of such transitions for financial stability. The preliminary results of our work will be published in our monthly newsletter, called “Primary Source,” and a column in the Phenomenal World Publication.
These columns put the ongoing structural breaks in different components of market microstructure into broader financial stability frameworks. In the classical finance literature, the market microstructure is an unfortunate system feature, so-called friction. In macroeconomics, this topic is entirely disregarded. In contrast, while we have a macro focus, namely financial stability, we treat market microstructure as a necessary foundation that continuously alters the quantity and quality of systemic fluidity. The goal is to provide a surgical understanding of the evolutions in market microstructure as they unfold and examine their implication for systemic risk.
In scholarly literature, the program stands at the intersection of three distinct disciplines: (1) macroeconomic theories of financial intermediation, (2) industrial organization models of market power, and (3) finance literature on market microstructure. This project connects this literature as they closely coexist in the real world, unlike how they are treated in academic scholarship. Nonetheless, even though scholarly pinnacles fully inform our assessments, this project distinguishes itself from the classical academic examination of such issues on at least two fronts.
First, while other emerging and closely related literature, such as “intermediary asset pricing,” focuses on the valuation of a particular market or instrument, our focus is on systemic fluidity. Second, to capture the realities of the market microstructure, rather than historical data, we use state-of-the-art research reports and the chronologies of major financial institutions as our primary sources. Our methodology is to let market practitioners speak. At the same time, to conduct the financial stability analysis, we use models, including academic frameworks, to cut through the many noises of such market-generated narratives. The goal is to understand the realities of the modern financial ecosystem while distinguishing structural transitions in market microstructure from cyclical and event-driven ones.