Catching Falling Knives: Speculating on Liquidity Shocks
54 Pages Posted: 17 Oct 2012 Last revised: 19 Nov 2015
There are 2 versions of this paper
Catching Falling Knives: Speculating on Liquidity Shocks
Catching Falling Knives: Speculating on Market Overreaction
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: Suggested Citation