Optimal Liquidity Trading

A liquidity trader wishes to trade a fixed number of shares within a certain time horizon and to minimize the mean and variance of the costs of trading. Explicit formulas for the optimal trading strategies show that risk-averse liquidity traders reduce their order sizes over time and execute a higher fraction of their total trading volume in early periods when price volatility or liquidity increases. In the presence of transaction fees, traders want to trade less often when either price volatility or liquidity goes up or when the speed of price reversion declines. In the multi-asset case, price effects across assets have a substantial impact on trading behavior.We are grateful to Prajit Dutta and Larry Glosten for numerous conversations and comments and to Marc Lipson for help with the Plexus data. Comments and suggestions of the referee and the editor, Josef Zechner, helped us improve the paper. We also thank the participants of the Chicago Board of Trade 13th Annual European Futures Research Symposium 2000 and the participants of the EFA Annual Meetings 2001.     

Market Liquidity and Trading Activity

Previous studies of liquidity span short time periods and focus on the individual security. In contrast, we study aggregate market spreads, depths, and trading activity for U.S. equities over an extended time sample. Daily changes in market averages of liquidity and trading activity are highly volatile and negatively serially dependent. Liquidity plummets significantly in down markets. Recent market volatility induces a decrease in trading activity and spreads. There are strong day-of-the-week effects; Fridays accompany a significant decrease in trading activity and liquidity, while Tuesdays display the opposite pattern. Long- and short-term interest rates influence liquidity. Depth and trading activity increase just prior to major macroeconomic announcements.     

Episodic Liquidity Crises: Cooperative and Predatory Trading

We describe how episodic illiquidity arises from a breakdown in cooperation between market participants. We first solve a one‐period trading game in continuous‐time, using an asset pricing equation that accounts for the price impact of trading. Then, in a multi‐period framework, we describe an equilibrium in which traders cooperate most of the time through repeated interaction, providing apparent liquidity to one another. Cooperation breaks down when the stakes are high, leading to predatory trading and episodic illiquidity. Equilibrium strategies that involve cooperation across markets lead to less frequent episodic illiquidity, but cause contagion when cooperation breaks down.     

Multimarket Trading and Liquidity: Theory and Evidence

We develop a new model of multimarket trading to explain the differences in the foreign share of trading volume of internationally cross‐listed stocks. The model predicts that the trading volume of a cross‐listed stock is proportionally higher on the exchange in which the cross‐listed asset returns have greater correlation with returns of other assets traded on that market. We find robust empirical support for this prediction using stock return and volume data on 251 non‐U.S. stocks cross‐listed on major U.S. exchanges.     

Liquidity Trading in Market Microstructure Theory

Liquidity trading is an important component of market microstructure models. In most cases, its role is primarily to ensure existence of equilibrium and therefore that trading occurs among asymmetrically informed agents. While most market microstructure models allege that agents trade based upon rational expectations, the rationality of the type of liquidity trading assumed in these models remains to be verified. Specifically, liquidity traders are often assumed to submit price-inelastic orders for reasons exogenous to the model at hand. But whether price-inelastic trading is consistent with rational utility maximizing behavior remains to be shown.     

Determinants of Trading Profits: The Liquidity Provision Decision

Theories show that liquidity provision implies negative contemporaneous correlation between trades and returns. Dealers on the Taiwan Stock Exchange are granted typical dealer trading advantages without obligations to provide liquidity and, thus, are ideal to test whether these advantages lead to voluntary liquidity provision (earning bid-ask spreads) or information trading (trading in the direction of the market). We find a strong positive correlation in aggregate, implying that these unrestricted dealers prefer information trading. We also find that smaller dealers are more likely to provide liquidity and that small-cap stocks (with larger bid-ask spreads) are more profitable for liquidity provision.     

交易所大宗交易流动性折价研究——来自沪深交易所的经验证据

随着证券市场规模的扩大及机构投资者规模的壮大，机构投资者对市场流动性的需求日益剧增，大宗交易制度是满足投资者流动性需求的制度性创新。由于大宗交易的数量较大，其交易价格有别于正常交易规模的价格。本文利用沪深交易所的大宗交易数据实证探讨大宗交易价格及其影响因素。研究结果表明，大部分大宗交易价格低于当日收盘价格，呈现流动性折价现象，折价率达到1．27％：研究还发现，折价水平还受交易数量、正常交易时间段股票流动性水平、市场流动性水平及股价波幅等因素影响。     

Trading and Liquidity on the Tokyo Stock Exchange: A Bird's Eye View

The trading mechanism for equities on the Tokyo Stock Exchange (TSE) stands in sharp contrast to the primary mechanisms used to trade stocks in the United States. In the United States, exchange-designated specialists have affirmative obligations to provide continuous liquidity to the market. Specialists offer simultaneous and tight quotes to both buy and sell and supply sufficient liquidity to limit the magnitude of price changes between consecutive transactions. In contradistinction, the TSE has no exchange-designated liquidity suppliers. Instead, liquidity is provided through a public limit order book, and liquidity is organized through restrictions on maximum price changes between trades that serve to slow down trading. In this article, we examine the efficacy of the TSE's trading mechanisms at providing liquidity. Our analysis is based on a complete record of transactions and best-bid and best-offer quotes for most stocks in the First Section of the TSE over a period of 26 months. We study the size of the bid-ask spread and its cross-sectional and intertemporal stability; intertemporal patterns in returns, volatility, volume, trade size, and the frequency of trades; and market depth based on the response of quotes to trades and the frequency of trading halts and warning quotes.     

Insider Trading, Investment, and Liquidity: A Welfare Analysis

We compare equilibrium trading outcomes with and without participation by an informed insider, assuming inflexible ex ante aggregate investment choices by agents. Noise trading arises from aggregate uncertainty regarding other agents' intertemporal consumption preferences. The welfare levels of outsiders can thus be ascertained. The allocations without insider trading are not ex ante Pareto efficient, because our model differs from standard ones with negative exponential utility functions and normal returns. We characterize the circumstances under which the revelation of payoff-relevant information via prices—arising from insider trading—benefits outsiders with stochastic liquidity needs, by improving risk-sharing among them.     

Liquidity Externalities and Adverse Selection: Evidence from Trading after Hours

This paper examines liquidity externalities by analyzing trading costs after hours. There is less than 1/20 as many trades per unit time after hours as during the trading day. The reduced trading activity results in substantially higher trading costs: quoted and effective spreads are three to four times larger than during the trading day. The higher spreads reflect greater adverse selection and order persistence, but not higher dealer profits. Because liquidity provision remains competitive after hours, the greater adverse selection and higher trading costs provide a direct measure of the magnitude of the liquidity externalities generated during the trading day.     

Strategic Trading, Liquidity, and Information Acquisition

We study endogenous liquidity trading in a market with long-livedasymmetric information. We distinguish between public information,tractable information that can be acquired, and intractableinformation that cannot be acquired. Besides information asymmetryand noise, the adverse-selection spread depends on the diffusionof intractable information and on the interest rate. With endogenousliquidity trading, efficiency is lower than that implied bynoise-trading models. Liquidity traders benefit from the informationreleased through the insider's trades in spite of their monetarylosses. We study factors that affect the insider's informationacquisition decision, including the amount of intractable information,observability, and information acquisition costs.     

Order Flow and Liquidity around NYSE Trading Halts

We study order flow and liquidity around NYSE trading halts. We find that market and limit order submissions and cancellations increase significantly during trading halts, that a large proportion of the limit order book at the reopen is composed of orders submitted during the halt, and that the market-clearing price at the reopen is a good predictor of future prices. Depth near the quotes is unusually low around trading halts, though specialists and/or floor traders appear to provide additional liquidity at these times. Finally, specialists appear to 'spread the quote' prior to imbalance halts to convey information to market participants.     

Liquidity Provision and Noise Trading: Evidence from the Investment Dartboard Column

How does increased noise trading affect market liquidity and trading costs? We use The Wall Street Journal's “Investment Dartboard” column, which stimulates noise trading, as a natural experiment to evaluate models of the bid-ask spread. We find that substantial increases in trading volume and significant but temporary abnormal returns occur when analysts recommend stocks in this column, especially when recommendations come from analysts with successful contest track records. We also find an increase in liquidity and a decrease in the adverse selection component of the bid-ask spread.     

The Effects of Trading Methods on Volatility and Liquidity: Evidence from the Taiwan Stock Exchange

This study contrasts the call and continuous auction methods using Taiwan Stock Exchange data. Volatility under the call market method is approximately one-half of that under the continuous auction method. The call market method is more effective in reducing the volatility of high-volume stocks than low-volume stocks. This contradicts conventional wisdom which suggests that the call market method is superior for thinly traded stocks, while the continuous auction method is preferred for heavily traded stocks. The call market method does not impair liquidity and price discovery. The call market appears more efficient than in the continuous auction market.     

Transparency and Liquidity: A Comparison of Auction and Dealer Markets with Informed Trading

Trading systems differ in their degree of transparency, here defined as the extent to which market makers can observe the size and direction of the current order flow. We investigate whether greater transparency enhances market liquidity by reducing the opportunities for taking advantage of uninformed participants. We compare the price formation process in several stylized trading systems with different degrees of transparency: various types of auction markets and a stylized dealer market. We find that greater transparency generates lower trading costs for uninformed traders on average, although not necessarily for every size of trade.     

Can Island Provide Liquidity and Price Discovery in the Dark?

On September 23, 2002, facing a regulatory mandate issued by the Securities and Exchange Commission, Island teminated the position of the Nasdaq 100 Index Tracking Stock (QQQ) on its book. While the market volume remained almost the same, Island's market share in the QQQ fell significantly. However, Island still dominates other trading centers in the price discovery process and volatility spillovers. The spreads on most trading centers became narrower after Island removed its quotes from the public view. The overall results suggest that the decrease in market transparency does not compromise market liquidity. Informed traders who provide price discovery in the QQQ are willing to sacrifice potential price improvements for the fast speed and reliable execution that Island offers, and are able to trade in the absence of displayed quotes.     

Is Off–Board Trading Detrimental to Market Liquidity?

Dual trading can have opposite effects: although competition between markets should induce dealers to offer cheaper transactions, market fragmentation could reduce market activity, liquidity, and exchange efficiency. This paper shows that for French stocks traded on the London Stock Exchange's SEAQ International (SEAQ–I), market activity decreases significantly in the Paris Bourse during UK bank holidays. Thus, SEAQ–I market makers seem to divert a new clientele to the Paris Bourse, increasing both market activity and the breadth of the Bourse's order book. Also, contrary to the fragmentation hypothesis, dual trading does not seem to increase information asymmetry.     

分业经营:我国流动牲过剩原因的一种新视角

本文从分业经营的金融体制这一角度探讨了我国流动性过剩的原因.首先分析了分业经营体制通过何种渠道造成了流动性过剩,然后对改革我国目前的分业经营体制,循序渐进的使分业经营的金融体制向混业经营过渡提出了建议.