Brokers and Order Flow Leakage: Evidence from Fire Sales
Forthcoming in Journal of Finance
61 Pages Posted: 23 Jun 2017 Last revised: 15 Oct 2019
Date Written: November 28, 2017
Using trade-level data, we study whether brokers play a role in spreading order flow information. We focus on large portfolio liquidations, which result in temporary drops in stock prices, and identify the brokers that intermediate these trades. We show that these brokers’ best clients tend to predate on the liquidating funds: at the beginning of the fire sale, they sell their holdings in the liquidated stocks, to then cover their positions once asset prices start recovering. The predatory trades generate at least 50 basis points over ten days and cause the liquidation costs for the distressed fund to almost double. These results suggest a role of brokers in fostering predatory behavior and raise a red flag for regulators. Moreover, our findings highlight the trade-off between slow execution and potential information leakage in the decision of optimal trading speed.
Keywords: Predatory Trading, Back Running, Fire Sales, Brokers
JEL Classification: G1, G12, G23, G24
Suggested Citation: Suggested Citation