Episodic liquidity crises: cooperative and predatory trading,”

ABSTRACT 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 and provide 'apparent liquidity' to each other. Cooperation breaks down when the stakes are high, leading to predatory trading and episodic illiquidity. Equilibrium strategies involving cooperation across markets lead to less frequent episodic illiquidity, but cause contagion when cooperation breaks down. * Bruce Ian Carlin, Miguel Sousa Lobo, and S. Viswanathan are from the Fuqua School of Business at Duke University. The authors would like to than

Doing Battle with Short Sellers: The Role of Blockholders in Bear Raids

Abstract. If short sellers can destroy firm value by manipulating prices down in a “bear raid,” an informed blockholder has a powerful natural incentive to protect the value of his stake by trading against them. However, he also has an incentive to use his information to generate trading profits. We show that these conflicting objectives create a multiplier effect, whereby the buying quantity needed to defeat the shorts becomes a large multiple of the expected amount of short selling. This increases trading profits when the blockholder buys at favorable prices, but also increases losses when he must buy at unfavorable prices. Thus, his existing stake needs to be large enough to absorb these losses. Importantly, though, the multiplier shrinks as the potential for value destruction increases, meaning a smaller stake is sufficient precisely when a successful bear raid would be most harmful. These results add a new dimension to the existing debate on when/whether intervention against short sellers is warranted

Momentum, Reversal, and Uninformed Traders in Laboratory Markets

We report the results of three experiments based on the model of Hong and Stein (1999) . Consistent with the model, the results show that when informed traders do not observe prices, uninformed traders generate long-term price reversals by engaging in momentum trade. However, when informed traders also observe prices, uninformed traders generate reversals by engaging in contrarian trading. The results suggest that a dominated information set is sufficient to account for the contrarian behavior observed among individual investors, and that uninformed traders may be responsible for long-term price reversals but play little role in driving short-term momentum. Copyright (c) 2009 the American Finance Association.