Financial Market Liquidity: Who is Acting Strategically?

43 Pages Posted: 6 Oct 2015 Last revised: 6 Jul 2016

See all articles by Serge Darolles

Serge Darolles

Université Paris Dauphine - DRM-CEREG

Gaëlle Le Fol

Université Paris-Dauphine, PSL Research University, CNRS, UMR 7088, DRM, Finance, 75016 Paris, France; National Institute of Statistics and Economic Studies (INSEE) - Center for Research in Economics and Statistics (CREST)

Gulten Mero

University of Cergy-Pontoise - THEMA; National Institute of Statistics and Economic Studies (INSEE) - Center for Research in Economics and Statistics (CREST)

Date Written: June 30, 2016

Abstract

In a new environment where liquidity providers as well as liquidity consumers act strategically, understanding how liquidity flows and dries-up is key. In this paper, we propose a dynamic extension of the seminal model of Tauchen and Pitts (1983)’ Mixture of Distributions Hypothesis (MDH) that specifies the impact of information arrival on market characteristics in the context of liquidity frictions. In our model, the daily price change and volume processes are represented by a bivariate mixture of distributions, conditioned by two latent time-persistent variables It and Lt. Since the price change and volume equations are nonlinear functions of the first latent variable It, we use an Extended Kalman Filter (EKF) to filter the two latent variables and estimate the model parameters, simultaneously. This procedure enables us to: (i) capture the impact of long-lasting liquidity frictions on the daily price change and volatility dynamics; (ii) separate out the impact of both long and short-lasting liquidity frictions, on the serial correlation of the daily volume. Our results show that, 48% (44/92) of the stocks of the FTSE100 are actually facing liquidity problems. Amongst these stocks, 28% (26/92) of them are also facing a slow-down in the information propagation in prices due to long-term investors’ strategic behavior.

Keywords: Strategic liquidity trading, market efficiency, mixture of distribution hypothesis, information-based trading, extended Kalman Filter

JEL Classification: C51, C52, G12, G14

Suggested Citation

Darolles, Serge and Le Fol, Gaëlle and Mero, Gulten, Financial Market Liquidity: Who is Acting Strategically? (June 30, 2016). Available at SSRN: https://ssrn.com/abstract=2669459 or http://dx.doi.org/10.2139/ssrn.2669459

Serge Darolles

Université Paris Dauphine - DRM-CEREG ( email )

place du Maréchal de Lattre de Tassigny
cedex 16
Paris, 75775
France

Gaëlle Le Fol

Université Paris-Dauphine, PSL Research University, CNRS, UMR 7088, DRM, Finance, 75016 Paris, France ( email )

Place du Maréchal de Lattre de Tassigny
Paris Cedex 16, 75775
France

National Institute of Statistics and Economic Studies (INSEE) - Center for Research in Economics and Statistics (CREST) ( email )

15 Boulevard Gabriel Peri
Malakoff Cedex, 1 92245
France

Gulten Mero (Contact Author)

University of Cergy-Pontoise - THEMA ( email )

33 boulevard du port
F-95011 Cergy-Pontoise Cedex, 95011
France

National Institute of Statistics and Economic Studies (INSEE) - Center for Research in Economics and Statistics (CREST) ( email )

15 Boulevard Gabriel Peri
Malakoff Cedex, 1 92245
France

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
103
Abstract Views
827
rank
269,316
PlumX Metrics