Liquidity, Resiliency and Market Quality Around Predictable Trades: Theory and Evidence

67 Pages Posted: 23 Mar 2012 Last revised: 21 Oct 2015

See all articles by Hendrik Bessembinder

Hendrik Bessembinder

Arizona State University

Allen Carrion

University of Utah - Department of Finance

Laura A. Tuttle

U.S. Securities and Exchange Commission - Division of Economic and Risk Analysis

Kumar Venkataraman

Southern Methodist University (SMU) - Finance Department

Date Written: October 20, 2015

Abstract

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.

Keywords: predatory trading, sunshine trading, trading costs, resiliency, ETFs, crude oil, energy, commodities, futures

JEL Classification: G1, G2

Suggested Citation

Bessembinder, Hendrik (Hank) and Carrion, Allen and Tuttle, Laura A. and Venkataraman, Kumar, Liquidity, Resiliency and Market Quality Around Predictable Trades: Theory and Evidence (October 20, 2015). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=2026802 or http://dx.doi.org/10.2139/ssrn.2026802

Hendrik (Hank) Bessembinder (Contact Author)

Arizona State University ( email )

PO Box 873906
Tempe, AZ 85207
United States

Allen Carrion

University of Utah - Department of Finance ( email )

David Eccles School of Business
Salt Lake City, UT 84112
United States

Laura A. Tuttle

U.S. Securities and Exchange Commission - Division of Economic and Risk Analysis ( email )

United States Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549
United States
202-551-6544 (Phone)

Kumar Venkataraman

Southern Methodist University (SMU) - Finance Department ( email )

United States
214-768-7005 (Phone)
214-768-4099 (Fax)

HOME PAGE: http://people.smu.edu/kumar/

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