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Financial Market Liquidity: Who Is Acting Strategically?

Author

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  • Gulten Mero

    (Université de Cergy-Pontoise, THEMA)

  • Serge Darolles
  • Gaëlle Le Fol

Abstract

In a new environment where liquidity providers as well as liquidity consumers act strategically, understanding how liquidity flows and dries-up is key. We propose a model that specifies the impact of information arrival on market characteristics, in the context of liquidity frictions. We distinguish short-lasting liquidity frictions, which impact intraday prices, from long-lasting liquidity frictions, when information is not fully incorporated into prices within the day. We link the first frictions to the strategic behavior of intraday liquidity providers and the second to the strategic behavior of liquidity consumers, i.e. long-term investors who split up their orders not to be detected. Our results show that amongst 61% of the stocks facing liquidity problems, 57% of them point up liquidity providers as the sole strategic market investor. Another 27% feature long-term investors as the single strategic player, while both liquidity providers and liquidity consumers act strategically in the remaining 16%. This means that 43% of these stocks are actually facing a slow-down in the information propagation in prices, which thus results in a significant decrease of (daily) price efficiency due to long-term investors’ strategic behavior.

Suggested Citation

  • Gulten Mero & Serge Darolles & Gaëlle Le Fol, 2015. "Financial Market Liquidity: Who Is Acting Strategically?," THEMA Working Papers 2015-14, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
    • Handle: RePEc:ema:worpap:2015-14
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    References listed on IDEAS

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    More about this item

    Keywords

    High Frequency trading; strategic liquidity trading; market efficiency; mixture of distribution hypothesis; information-based trading; order splitting; Markov regime-switching stochastic volatility model.;
    All these keywords.

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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