The Effects of Institutional Risk Control on Trader Behavior

Journal of Applied Finance, Fall/Winter 2008, Vol. 18, Issue 2, pp. 22-35

Posted: 27 Jul 2012

See all articles by Ryan Garvey

Ryan Garvey

University College Dublin - Department of Economics

Fei Wu

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)

Date Written: 2008

Abstract

We examine how institutional risk control mechanisms influence proprietary stock trader behavior. When traders are forced to liquidate their inventory at a pre-designated time, they often hold onto their losing trades until the very last moment. We find that the difference between losing and winning round-trip holding times systematically widens leading up to an inventory liquidation deadline and trading becomes less driven by trading practices and more induced by the firm's control mechanism as the deadline draws near. When trade price is heavily controlled yet trade size isn't, we find that the difference between losing and winning round-trip holding times systematically widens with trade size. This result suggests traders increase their risk-taking in areas where institutional control mechanisms are weaker. Our findings highlight the difficult balancing act firms face with getting market professionals to realize their losses without impeding their trading strategies.

Suggested Citation

Garvey, Ryan and Wu, Fei, The Effects of Institutional Risk Control on Trader Behavior (2008). Journal of Applied Finance, Fall/Winter 2008, Vol. 18, Issue 2, pp. 22-35, Available at SSRN: https://ssrn.com/abstract=1652822

Ryan Garvey (Contact Author)

University College Dublin - Department of Economics ( email )

Dublin 4, 4
Ireland

Fei Wu

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

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