Price Pressures

33 Pages Posted: 31 May 2009 Last revised: 18 Feb 2015

Terrence Hendershott

University of California, Berkeley - Haas School of Business

Albert J. Menkveld

VU University Amsterdam; Tinbergen Institute - Tinbergen Institute Amsterdam (TIA)

Date Written: June 30, 2014

Abstract

We study price pressures, i.e., deviations from the efficient price due to risk-averse intermediaries supplying liquidity to asynchronously arriving investors. Empirically, New York Stock Exchange intermediary data reveals economically large price pressures, 0.49% on average with a half life of 0.92 days. Theoretically, a simple dynamic inventory model captures an intermediary’s use of price pressure to mean-revert inventory. She trades off revenue loss due to price pressure against price risk associated with staying in a nonzero inventory state. The closed-form solution identifies the intermediary’s risk aversion and the investors’ private value distribution from the observed time series patterns of prices and inventories. These parameters imply a relative social cost due to price pressure, a deviation from constrained Pareto efficiency, of approximately 10% of the cost of immediacy.

Keywords: liquidity, inventory risk, intermediary, volatility

JEL Classification: G12, G14, D53, D61

Suggested Citation

Hendershott, Terrence and Menkveld, Albert J., Price Pressures (June 30, 2014). Journal of Financial Economics, 2014, Vol 114, p. 405-423.. Available at SSRN: https://ssrn.com/abstract=1411943

Terrence J. Hendershott

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

Albert J. Menkveld (Contact Author)

VU University Amsterdam ( email )

De Boelelaan 1105
Amsterdam, 1081HV
Netherlands
+31 20 5986130 (Phone)
+31 20 5986020 (Fax)

Tinbergen Institute - Tinbergen Institute Amsterdam (TIA) ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

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