Market Structure and Effect of Sentiment on Liquidity

35 Pages Posted: 6 Mar 2008

Abstract

This paper examines how market structure influences the channel through which investor sentiment affects liquidity. Theory predicts that higher irrational investor sentiment is associated with lower illiquidity but through different channels. Thus, market structure has implications for return continuation, a result of underreaction to information. In a market with a specialist market maker, there is no underreaction to information in the orderflow and hence return continuation is not affected by investor sentiment. However, in a market without a specialist market maker, irrational traders underreact to the information in the order flow and hence higher investor sentiment is associated with higher return continuation. The empirical evidence supports these predictions. For both NYSE as well as Nasdaq, illiquidity is lower in the periods of high investor sentiment. Return continuation for Nasdaq, but not for NYSE, is higher in periods of high sentiment.

Keywords: Liqudity, sentiment, market structure, underreaction

JEL Classification: G14, G19

Suggested Citation

Deuskar, Prachi, Market Structure and Effect of Sentiment on Liquidity. Available at SSRN: https://ssrn.com/abstract=1100171 or http://dx.doi.org/10.2139/ssrn.1100171

Prachi Deuskar (Contact Author)

Indian School of Business ( email )

Hyderabad, Gachibowli 500 019
India

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
145
Abstract Views
560
rank
88,454
PlumX Metrics