Catching Falling Knives: Speculating on Liquidity Shocks

54 Pages Posted: 17 Oct 2012 Last revised: 19 Nov 2015

Multiple version iconThere are 2 versions of this paper

Date Written: November 18, 2015

Abstract

Many market participants invest resources to acquire information about liquidity rather than fundamentals. I show that agents using such information can reduce the magnitude of short-lived pricing errors by trading against liquidity shocks. However, the short-run stabilizing effect of this behavior also makes it more difficult to identify liquidity shocks, a signal-jamming effect that slows down price discovery in the long-run. As more agents invest in non-fundamental information, market prices become more resilient to liquidity shocks, but also recover more slowly from temporary price deviations.

Keywords: supply information, non-fundamental uncertainty, market crashes, arbitrage

JEL Classification: D82, G0, G12, G14

Suggested Citation

Colliard, Jean-Edouard, Catching Falling Knives: Speculating on Liquidity Shocks (November 18, 2015). Available at SSRN: https://ssrn.com/abstract=2163080 or http://dx.doi.org/10.2139/ssrn.2163080

Jean-Edouard Colliard (Contact Author)

HEC Paris - Finance Department ( email )

France

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