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Liquidity, resiliency and market quality around predictable trades: Theory and evidence

Author

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  • Bessembinder, Hendrik
  • Carrion, Allen
  • Tuttle, Laura
  • Venkataraman, Kumar

Abstract

We extend the theory of strategic trading around a predictable liquidation by considering the role of market resiliency. Our model predicts that even a monopolist strategic trader improves market quality and increases liquidator proceeds if trades’ temporary price impacts are quickly reversed, and that competition among strategic traders strictly improves market quality. We provide related empirical evidence by studying prices, liquidity, and individual account trading activity around the large and predictable “roll” trades undertaken by a large exchange-traded fund (ETF). The evidence indicates narrower bid-ask spreads, greater order book depth, and improved resiliency on roll dates. We find that a larger number of individual trading accounts provide liquidity on roll dates, and do not find evidence of the systematic use of predatory strategies. On balance, the theory and evidence imply that traders supply liquidity to rather than exploit predictable trades in resilient markets.

Suggested Citation

  • Bessembinder, Hendrik & Carrion, Allen & Tuttle, Laura & Venkataraman, Kumar, 2016. "Liquidity, resiliency and market quality around predictable trades: Theory and evidence," Journal of Financial Economics, Elsevier, vol. 121(1), pages 142-166.
    • Handle: RePEc:eee:jfinec:v:121:y:2016:i:1:p:142-166
    DOI: 10.1016/j.jfineco.2016.02.011
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    References listed on IDEAS

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    More about this item

    Keywords

    Predatory trading; Sunshine trading; Resiliency; ETFs; Trading costs; Commodity trading;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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