Articles

Catching Falling Knives: Speculating on Liquidity Shocks

J. E. COLLIARD

Management Science

August 2017, vol. 63, n°8, pp.2573-2591

Departments: Finance, GREGHEC (CNRS)

Keywords: supply information • nonfundamental uncertainty • market crashes • arbitrage • high-frequency trading

http://pubsonline.informs.org/doi/pdf/10.1287/mnsc.2016.2440


Many market participants invest resources to acquire information about liquidity rather than fundamentals. I show that agents using such information can reduce the magnitude of short-lived pricing errors by trading against liquidity shocks. However, the short-run stabilizing effect of this behavior also makes it more difficult to identify liquidity shocks, a signal-jamming effect that slows down price discovery in the long run. As more agents invest in nonfundamental information, market prices become more resilient to liquidity shocks but also recover more slowly from temporary price deviations.


JavaScriptSettings