Market Liquidity and Heterogeneity in the Investor Decision Cycle

26 Pages Posted: 22 Aug 2015

See all articles by Richard M. Bookstaber

Richard M. Bookstaber

Board of Regents - University of California Office of the CIO

Michael Foley

University of Vermont

Brian Tivnan

The MITRE Corporation; University of Vermont - College of Engineering and Mathematics

Date Written: March 10, 2015

Abstract

During liquidity shocks such as occur when margin calls force the liquidation of leveraged positions, there is a widening disparity between the reaction speed of the liquidity demanders and the liquidity providers. Those who are forced to sell typically must take action within the span of a day, while those who are providing liquidity do not face similar urgency. Indeed, the flurry of activity and increased volatility of prices during the liquidity shocks might actually reduce the speed with which many liquidity providers come to the market. To analyze these dynamics, we build upon previous agent-based models of financial markets to develop an order-book model with heterogeneity in trader decision cycles. The model demonstrates an adherence to important stylized facts such as a leptokurtic distribution of returns, decay of autocorrelations over moderate to long time lags, and clustering volatility. We show that the heterogeneity in decision cycles can increase the severity of market shocks, and even absent a shock can have notable effects on the stochastic properties of market prices.

Suggested Citation

Bookstaber, Richard M. and Foley, Michael and Tivnan, Brian, Market Liquidity and Heterogeneity in the Investor Decision Cycle (March 10, 2015). Office of Financial Research Working Paper No. 15-03, Available at SSRN: https://ssrn.com/abstract=2648459 or http://dx.doi.org/10.2139/ssrn.2648459

Richard M. Bookstaber (Contact Author)

Board of Regents - University of California Office of the CIO ( email )

1111 Broadway
Oakland, CA 94607
United States

Michael Foley

University of Vermont ( email )

212 Kalkin Hall
Burlington, VT 05405-0158
United States

Brian Tivnan

The MITRE Corporation ( email )

202 Burlington Road
Bedford, MA 01730
United States

University of Vermont - College of Engineering and Mathematics ( email )

United States

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