Price Impact and Bursts In Liquidity Provision

41 Pages Posted: 11 Mar 2016 Last revised: 15 Oct 2016

See all articles by Ramazan Gencay

Ramazan Gencay

Simon Fraser University

Soheil Mahmoodzadeh

University of Cambridge - Faculty of Economics

Jakub Rojcek

University of Zurich, Department of Banking and Finance; Swiss Finance Institute

Michael Tseng

Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne

Date Written: September 10, 2016

Abstract

This paper analyzes brief episodes of high-intensity quotes turnover and revision-"bursts" in quotes-in the U.S. equity market. Such events occur very frequently, several hundred times a day for actively traded stocks. We find significant price impact associated with these market makers initiated events, about five times higher than during non-burst periods. Bursts in quotes are concurrent with short-lived structural breaks in the informational relationship between market makers and market takers. During bursts, market makers no longer passively impound information from order flow into quotes-a departure from the traditional market microstructure paradigm. Rather, market makers significantly impact prices during bursts in quotes. Further analysis shows that there is asymmetry in adverse selection between the bid and ask sides of the limit order book and only a sub-population of market makers enjoys an informational advantage during bursts. Market makers on the side opposite of the burst suffer elevated adverse selection costs, while market makers on the side of the burst realize positive spread, irrespective of the order flow direction. Our results call attention to the need for a new microstructure perspective in understanding modern high-frequency limit order book markets and the quote manipulation strategies at disposal of the fast market makers.

Keywords: Price Impact, Burst, High-Frequency Trading, Market Quality, Adverse Selection

JEL Classification: G14, G28, C58

Suggested Citation

Gencay, Ramazan and Mahmoodzadeh, Soheil and Rojcek, Jakub and Tseng, Michael, Price Impact and Bursts In Liquidity Provision (September 10, 2016). Swiss Finance Institute Research Paper No. 16-21. Available at SSRN: https://ssrn.com/abstract=2745342 or http://dx.doi.org/10.2139/ssrn.2745342

Ramazan Gencay

Simon Fraser University ( email )

Department of Economics
8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada

Soheil Mahmoodzadeh

University of Cambridge - Faculty of Economics ( email )

Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom

Jakub Rojcek (Contact Author)

University of Zurich, Department of Banking and Finance ( email )

Schönberggasse 1
Zürich, 8001
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

Michael Tseng

Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne ( email )

Quartier UNIL-Dorigny, Bâtiment Extranef, # 211
40, Bd du Pont-d'Arve
CH-1015 Lausanne, CH-6900
Switzerland

HOME PAGE: http://sfi.epfl.ch/cms/site/sfi/lang/en/michaeltseng

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