Liquidity, Resiliency and Market Quality Around Predictable Trades: Theory and Evidence
Arizona State University
University of Utah - Department of Finance
Laura A. Tuttle
U.S. Securities and Exchange Commission - Division of Economic and Risk Analysis
Southern Methodist University (SMU) - Edwin L. Cox School of Business
October 20, 2015
Journal of Financial Economics (JFE), Forthcoming
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. We provide related empirical evidence by studying prices, liquidity, and individual account trading activity around the large and predictable “roll” trades undertaken by the largest ETF tracking crude oil futures prices. 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 supports that strategic traders choose to provide liquidity to predictable trades in resilient markets. However, the large volume of trading associated with the roll transactions leads to substantial trade execution costs that average three percent per year.
Number of Pages in PDF File: 67
Keywords: predatory trading, sunshine trading, trading costs, resiliency, ETFs, crude oil, energy, commodities, futures
JEL Classification: G1, G2
Date posted: March 23, 2012 ; Last revised: October 21, 2015
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