Information,sell-side research,and market making

The interaction between an investment bank's research and market making arms may have important implications for the trading of a firm's stock. We investigate the impact that research has on the liquidity provided by the bank's market maker. Utilizing a large sample of Nasdaq firms, we show that market makers whose banks also provide research coverage provide more liquidity and contribute more to price discovery than do market makers without such research coverage. Finally, we show that such “affiliated” market makers are less affected by uncertainty following earnings announcements. Our results provide new evidence on the sources of liquidity improvements for Nasdaq firms, and suggest that the information produced by banks in the sell-side research process is beneficial to their market makers.     

Local market makers, liquidity and market quality

We examine the role of geographically proximate (local) market makers in providing liquidity and improving the quality of a dealer market. Firms with active participation of local dealers enjoy lower quoted and effective spreads, as well as more informative prices. The beneficial effects from local market makers are not confined to a few “top” local dealers and they cannot be attributed to their participation in the firm's IPO syndicate or industry specialization. Further, we find that days with aggressive bidding from local market makers relative to their non-local counterparts are associated with significant positive abnormal returns, consistent with local market makers possessing information advantages. In summary, our results suggest that the information advantages of local market makers may be a contributing factor to the reduction in the cost of trading.     

The Declining Role of NASDAQ Market Makers

We compare the liquidity providing behavior of NASDAQ market makers in 2010 to their behavior in 2004. We examine how frequently market makers are at the inside quote, what market and stock specific factors influence market makers’ behavior, and the relation between market maker participation and intraday bid‐ask spread patterns. We observe a decrease in the percent of the trading day dealers’ quote at the inside, a decline in the number of market makers, and a decrease in the influence market makers have on intraday spread patterns. The results suggest that the role of NASDAQ market makers declines over time.     

The impact of joint participation on liquidity in equity and syndicated bank loan markets

Market liquidity is impacted by the presence of financial intermediaries that are informed and active participants in both the equity and the syndicated bank loan markets, specifically informationally advantaged lead arrangers of syndicated bank loans that simultaneously act as equity market makers (dual market makers). Employing a two-stage procedure with instrumental variables, we identify the simultaneous equations model of liquidity and dual market maker decisions. We find that the presence of dual market makers improves the liquidity of the more competitive and transparent equity markets, but widens the spread in the less competitive over-the-counter loan market, particularly for small, informationally opaque firms.     

An empirical analysis of the supply of liquidity by locals in futures markets: Evidence from the Sydney Futures Exchange

Contrary to the received view of market makers in theoretical literature, this study provides direct evidence that locals on the Sydney Futures Exchange (SFE) do not trade exclusively as passive market participants. In fact, rather than act purely as market makers, locals as a group are almost as likely to demand as supply liquidity. Further, locals trading on the floor of the SFE are less likely to supply liquidity when bid–ask spreads, trading frequency and price volatility are high, as well as around information announcements. These findings are consistent with aggressive trading by locals on the basis of a short-lived information advantage. This study also documents considerable diversity in the propensity of locals to supply liquidity, finding that it is related to the quantity, frequency and average size of their trading activity.     

VPIN,liquidity, and return volatility in the U.S. equity markets

We examine the volume-synchronized probability of informed trading metric (the VPIN flow toxicity metric, developed by Easley, Lopez de Prado, & O'Hara, 2012) as a real-time risk management tool for liquidity deteriorations in the U.S. equity markets. We find that VPIN provides information about market liquidity and stock return volatility on ex-ante basis. These results indicate that VPIN can be a useful risk-management tool for market makers, regulators and traders in the U.S. equity markets. We also document that VPIN is negatively associated with volume and number of trades, but positively associated with trade size and volume fragmentation. These findings suggest that VPIN indicates the adverse selection problem of liquidity providers by capturing the information in volume.     

DO TRACKING STOCKS REDUCE INFORMATION ASYMMETRIES? AN ANALYSIS OF LIQUIDITY AND ADVERSE SELECTION

A firm's announcement that it intends to restructure based on tracking stock is usually associated with a positive stock price reaction, at least in the short run. Typically, this reaction is attributed to expected reductions in a diversification discount, through reduced agency costs or information asymmetries. We reinvestigate this latter hypothesis by focusing on the liquidity provided by market makers before and after a firm issues a tracking stock. Our results suggest that such restructurings are not effective at reducing information asymmetries. Rather, firms that issue tracking stocks exhibit less liquidity and greater adverse selection than comparable control firms.     

Strategic trading and learning about liquidity

Many practitioners point out that the speculative profits of institutional traders are eroded by the difficulty in gauging the price impact of their trades. In this paper, we develop a model of strategic trading where speculators face such a dilemma because of incomplete information about time-varying market liquidity. Unlike the competitive market makers that they trade against, informed traders do not know the distribution of liquidity (“noise”) trades. Instead, they have to learn about liquidity from past prices and trading volume. This learning implies that strategic trades and market statistics such as informational efficiency are path-dependent on past market outcomes. Our paper also has normative implications for practitioners.     

Trade Disclosure,Information Learning and Securities Market Performance

In this paper we examine the effect of information disclosure on securities market performance when liquidity traders are able to acquire information about inside trading. We show that the bid-ask spread increases with the liquidity trader's learning efficiency, which is greater when trade information is disclosed. The bid-ask spread is always higher when trade information is not disclosed. However, the discrepancy between the bid-ask spreads with and without information disclosure narrows when the learning efficiency increases. We also show that the gains of the informed traders in a market without trade information disclosure are reduced in the presence of the liquidity trader's learning. Nevertheless, liquidity traders do not necessarily benefit from increased transparency. In particular, liquidity traders may face higher trading costs.     

柜台市场会计信息披露研究——国外文献述评与启示

会计信息披露是降低信息不对称的重要方式,柜台市场信息的不对称影响做市商的报价价差,从而影响市场的流动性。本文分别围绕会计信息披露对买卖价差的影响、会计信息披露对市场流动性的影响、会计信息披露与柜台市场有效性的关系三方面,对国外文献进行梳理和分析,并阐明会计信息披露对构建我国柜台市场的重要意义。     

Order imbalance and liquidity supply: Evidence from the bubble burst of Nasdaq stocks

In this study we analyze the effect of order imbalance on the quotation behavior of Nasdaq market makers. We find that Nasdaq market makers use both price and quantity quotes when dealing with order imbalances. However, order imbalance affects only price movement, not spreads. We also find that Nasdaq market makers quote more shares and compete more intensively on bid-side (ask-side) when public sells (buys) exceed public buys (sells). These suggest that market makers increase liquidity supply when order imbalances exist. More interestingly, we show that both market conditions and price movements affect investors' trading behavior.     

Option market liquidity: Commonality and other characteristics

This study examines option market liquidity using Ivy DB's OptionMetrics data. We establish convincing evidence of commonality for various liquidity measures based on the bid–ask spread, volumes, and price impact. The commonality remains strong even after controlling for the underlying stock market's liquidity and other liquidity determinants such as volatility. Smaller firms and firms with a higher volatility exhibit stronger commonalities in option liquidity. Aside from commonality, we also uncover several other important properties of the option market's liquidity. First, information asymmetry plays a much more dominant role than inventory risk as a fundamental driving force of liquidity. Second, the market-wide option liquidity is closely linked to the underlying stock market's movements. Specifically, the options liquidity responds asymmetrically to upward and downward market movements, with calls reacting more in up markets and puts reacting more in down markets.     

The impact of aggressive orders in an order-driven market: a simulation approach

This article investigates resiliency in an order-driven market. On basis of a vector autoregressive model capturing various dimensions of liquidity and their interactions, I simulate the effect of a large liquidity shock, measured by a very aggressive market order. I show that, despite the absence of market makers, the market is resilient. All dimensions of liquidity (spread, depth at the best prices and order book imbalances) revert to their steady-state values within 15 orders after the shock. For prices, a long run effect is found. Furthermore, different dimensions of liquidity interact. Immediately after a liquidity shock, the spread becomes wider than in the steady state, implying that one dimension of liquidity deteriorates, while at the same time, depth at the best prices increases, meaning an improvement of another liquidity dimension. In subsequent periods, the spread reverts back to the steady-state level but also depth decreases. Also, I find evidence for asymmetries in the impact of shocks on the ask and bid side. Shocks on the ask side have a stronger impact than shocks on the bid side. Finally, resiliency is higher for less-frequently traded stocks and stocks with a larger relative tick size.     

Effect of corporate disclosure and press media on market liquidity: Evidence from Japan

News on corporate information can enhance clarity or add to confusion for market participants, especially investors. We explore how two diverse types of information dissemination —corporate disclosure and media coverage—influence stock market liquidity by mediating information asymmetries. We conclude that the two information inflows have notable and distinct impacts on liquidity. Our chief finding suggests that information from corporate disclosures induces a wider bid-ask spread, consistent with increased information asymmetries among investors. In contrast, we find that press media coverage—both good and bad news—improves liquidity. This indicates that mass media is a critical channel that provides investors with news to mitigate information uncertainty. Further, this media effect is partly driven by original journalism coverage and assistance for investors' information assimilation. Finally, in the case of stocks in which retail investors' participation is greater, the liquidity-improving effect of mass media is more prominent.     

VOLATILITY AND LIQUIDITY AT NYSE OPENING CALLS: A CLOSER LOOK

The literature suggests that the bid-ask spread is responsible, at least in part, for greater price volatility and more negative autocorrelation at the open than at the close. In this study, we find that these phenomena are not related to the bid-ask spread, but are related instead to pricing errors by specialists or limit-order traders around the open. We use George, Kaul, and Nimalendran's (1991) model, which is less biased than Roll's (1984) model, to estimate the implied spread. The results show that, on average, the implied spread earned by liquidity suppliers is lower at the open than at the close. These results refute the contention that specialists exploit their monopoly position and earn a higher profit at the opening call. The evidence is consistent with the hypothesis that specialists set a lower cost of immediacy to encourage trading and the release of more information at the opening call. This could reduce information asymmetry and make subsequent trades in the continuous market more profitable.     

Risk aversion, market liquidity, and price efficiency

A model of a noncompetitive speculative market is analyzed inwhich privately informed traders and market makers are riskaverse. Market liquidity is found to nonmonotonic in the numberof informed traders, their degree of risk aversion, and theprecision of their information. It is also shown that increasedliquidity trading leads to reduced priced efficiency, and that,under endogenous information acquisition, market liquidity mayalso be nonmonotonic in the variance of liquidity trades.     

Can hedge funds time market liquidity?

We explore a new dimension of fund managers' timing ability by examining whether they can time market liquidity through adjusting their portfolios' market exposure as aggregate liquidity conditions change. Using a large sample of hedge funds, we find strong evidence of liquidity timing. A bootstrap analysis suggests that top-ranked liquidity timers cannot be attributed to pure luck. In out-of-sample tests, top liquidity timers outperform bottom timers by 4.0–5.5% annually on a risk-adjusted basis. We also find that it is important to distinguish liquidity timing from liquidity reaction, which primarily relies on public information. Our results are robust to alternative explanations, hedge fund data biases, and the use of alternative timing models, risk factors, and liquidity measures. The findings highlight the importance of understanding and incorporating market liquidity conditions in investment decision making.     

Repo market – A tool to manage liquidity in financial institutions

Central Bank Repo (Repurchase Agreement) is widely used as an indirect instrument of monetary policy and the same is implemented in India by institutionalizing a mechanism called Liquidity Adjustment Facility (LAF) which allows banks and primary dealers to manage their liquidity requirement on day to day basis. Liquidity stress in the market has an impact on the short-term interest rate. Entities not having adequate securities balances borrow funds from inter-bank uncollateralized call market and the call rates are prone to liquidity shocks in the system. The spread between call and repo rates is likely to widen when there is liquidity stress in the market. The study tried to find the determinant of the spread. It found that LAF window activity as well as total money market activity has an impact on the spread. In order to understand if the spread behaves in a different manner when the system has excess liquidity vis-à-vis shortage of liquidity, a regime switching model using Goldfeld and Quandt’s D-method for switching regression was used. The tests found that the monetary policy is stable in both the regimes and the effectiveness of monetary policy in both the regimes is not statistically different.     

Limit order books and trade informativeness

In the microstructure literature, information asymmetry is an important determinant of market liquidity. The classic setting is that uninformed dedicated liquidity suppliers charge price concessions when incoming market orders are likely to be informationally motivated. In limit order book (LOB) markets, however, this relationship is less clear, as market participants can switch roles, and freely choose to immediately demand or patiently supply liquidity by submitting either market or limit orders. We study the importance of information asymmetry in LOBs based on a recent sample of 30 German Deutscher Aktienindex (DAX) stocks. We find that Hasbrouck's (1991) measure of trade informativeness Granger causes book liquidity, in particular that required to fill large market orders. Picking-off risk due to public news-induced volatility is more important for top-of-the book liquidity supply. In our multivariate analysis, we control for volatility, trading volume, trading intensity and order imbalance to isolate the effect of trade informativeness on book liquidity.     

The contribution of market makers to liquidity and efficiency of options trading in electronic markets

This paper examines the contribution of market makers to the liquidity and the efficiency of the options market in a unique setup of an order-driven computerized trading system, in which market makers and other participants operate under equitable conditions. The main findings are: (1) liquidity increased – a 60% increase in trading volume and a 35% decrease of bid–ask spreads; (2) the efficiency of shekel–euro options trading improved – deviations from put–call parity decreased significantly by 12%, and skewness decreased by about 30%. We also find that the net cost to the exchange is out weighted by the benefit to the trading public and that the presence of market makers encouraged trading between other participants far beyond their own trading.