Recovery from fast crashes: Role of mutual funds

We study the role mutual funds play in the recovery from fast intraday crashes based on data from the National Stock Exchange of India for a single large stock. During normal times, trading activity and liquidity provision by mutual funds is negligible compared to other traders at around 4% of overall activity. Nevertheless, for the two intraday market-wide crashes in our sample, price recovery took place only after mutual funds moved in. Market stability may require the presence of well-capitalized standby liquidity providers for recovery from fast crashes

The Propagation of Shocks Across International Equity Markets: A Microstructure Perspective

We study the high-frequency propagation of shocks across international equity markets. We identify intraday shocks to stock prices, liquidity, and trading activity for 12 equity markets around the world based on non-parametric jump statistics at the 5-minute frequency from 1996 to 2011. Shocks to prices are prevalent and large, with regular spillovers across markets – even within the same 5-minute interval. We find that price shocks are predominantly driven by information rather than liquidity. Consistent with the information channel, price shocks do not revert and often occur around macroeconomic news announcements. Liquidity shocks tend to be isolated events that are neither associated with price shocks nor with liquidity shocks on other markets. Our results challenge the widespread view that liquidity plays an important role in the origination and propagation of financial market shocks

Non-Standard Errors

In statistics, samples are drawn from a population in a data-generating process (DGP). Standard errors measure the uncertainty in estimates of population parameters. In science, evidence is generated to test hypotheses in an evidence-generating process (EGP). We claim that EGP variation across researchers adds uncertainty: Non-standard errors (NSEs). We study NSEs by letting 164 teams test the same hypotheses on the same data. NSEs turn out to be sizable, but smaller for better reproducible or higher rated research. Adding peer-review stages reduces NSEs. We further find that this type of uncertainty is underestimated by participants

Paying for Market Liquidity: Competition and Incentives

Do competition and incentives offered to designated market makers (DMMs) improve market liquidity? Using data from NYSE Euronext Paris, we show that an exogenous increase in competition among DMMs leads to a significant decrease in quoted and effective spreads, mainly through a reduction in adverse selection costs. In contrast, changes in incentives, through small changes in rebates and requirements for DMMs, do not have any tangible effect on market liquidity. Our results are of relevance for designing optimal contracts between exchanges and DMMs and for regulatory market oversight

Internet appendix for "coming early to the party"

This supplemental appendix presents further institutional details about the NYSE Euronext Paris market as well as additional analyses on the order flow and the behavior of the market participants

How Do Shocks Arise and Spread Across Stock Markets? A Microstructure Perspective

We study intraday, market-wide shocks to stock prices, market liquidity, and trading activity on international stock markets and assess the relevance of recent theories on “liquidity dry-ups” in explaining such shocks. Market-wide price shocks are prevalent and large, with rapid spillovers across markets. However, price shocks are predominantly driven by information; they do not revert and are often associated with macroeconomic news. Furthermore, liquidity shocks are typically isolated and transitory. Overall, we find little evidence for liquidity effects fomenting price shocks or non-fundamental contagion, nor for alternative explanations. Market-wide liquidity dry-ups are thus of little concern to international investors

Low-Latency Trading and Price Discovery without Trading: Evidence from the Tokyo Stock Exchange in the Pre-Opening Period and the Opening Batch Auction

We study whether the presence of low-latency traders (including high-frequency traders (HFTs)) in the pre-opening period contributes to price discovery in the subsequent opening call auction and the continuous trading session. Our analysis evokes shades of the debate on the switch from the current continuous auction in many markets to a periodic auction, affecting the speed advantage of low-latency traders. We empirically investigate these questions using a unique dataset based on server IDs provided by the Tokyo Stock Exchange (TSE), one of the largest stock markets in the world. Our data allow us to develop a more comprehensive classification of traders than in the prior literature, and to investigate the behavior of the different categories of traders, based on their capability for low-latency trading. We find that, perhaps due to the lack of immediate execution, about three quarters of the low-latency traders do not participate in the pre-opening period, but do participate in and dominate the continuous trading session. Furthermore, we find that the larger presence of low-latency traders in the trading of a stock in the pre-opening period as well as in the continuous session improves the price discovery process. Our results suggest that HFTs may not participate in trading in the periodic batch auction because of a lack of immediate execution, and that this large reduction in HFT participation may impede the quality of price discovery

How Do Shocks Arise and Spread Across Stock Markets? A Microstructure Perspective

We study intraday, market-wide shocks to stock prices, market liquidity, and trading activity on international stock markets and assess the relevance of recent theories on “liquidity dry-ups” in explaining such shocks. Market-wide price shocks are prevalent and large, with rapid spillovers across markets. However, price shocks are predominantly driven by information; they do not revert and are often associated with macroeconomic news. Furthermore, liquidity shocks are typically isolated and transitory. Overall, we find little evidence for liquidity effects fomenting price shocks or non-fundamental contagion, nor for alternative explanations. Market-wide liquidity dry-ups are thus of little concern to international investors

Stock Price Crashes: Role of Slow-Moving Capital

We study the role of various trader types in providing liquidity in spot and futures markets based on complete order-book and transactions data as well as cross-market trader identifiers from the National Stock Exchange of India for a single large stock. During normal times, short-term traders who carry little inventory overnight are the primary intermediaries in both spot and futures markets, and changes in futures prices Granger-cause changes in spot prices. However, during two days of fast crashes, Granger-causality ran both ways. Both crashes were due to large-scale selling by foreign institutional investors in the spot market. Buying by short-term traders and cross-market traders was insufficient to stop the crashes. Mutual funds, patient traders with better trade-execution quality who were initially slow to move in, eventually bought sufficient quantities leading to price recovery in both markets. Our findings suggest that market stability requires the presence of well-capitalized standby liquidity providers