Does Frequent Trading Always Improve Liquidity?

26 Pages Posted: 19 Jun 2002

See all articles by Philip Y. K. Cheng

Philip Y. K. Cheng

Nanyang Technological University (NTU) - Nanyang Business School

Saji Gopinath

Regional Engineering College, India

Chandrasekhar Krishnamurti

Nanyang Business School

Abstract

A liquid stock trades more often. The converse of that statement implies that more trading should make a stock more liquid. Extant research does not yet provide unambiguous answer to the critical question: Does more trading make a stock more liquid? We address this important issue using transaction data on a sample of stocks listed on the New York Stock Exchange. We document interesting cross-sectional differences when we categorize stocks on the basis of market capitalization. While more frequent trading is associated with an improvement in liquidity, as proxied by the bid-ask spread, for large market capitalization stocks, the converse is true for small stocks. We probe further and document that the deterioration in liquidity of small stocks, due to more frequent trading, is attributable to a direct increase in the adverse selection component of the bid-ask spread. Our evidence is consistent with the view that when specialists encounter more trading activity for small stocks they perceive increased levels of informational trading.

Keywords: Trading activity, information asymmetry, liquidity, adverse selection, and volatility

JEL Classification: G10, G12, G13

Suggested Citation

Cheng, Philip Y. K. and Gopinath, Saji and Krishnamurti, Chandrasekhar, Does Frequent Trading Always Improve Liquidity?. EFMA 2002 London Meetings. Available at SSRN: https://ssrn.com/abstract=314384 or http://dx.doi.org/10.2139/ssrn.314384

Philip Y. K. Cheng

Nanyang Technological University (NTU) - Nanyang Business School ( email )

Singapore, 639798
Singapore
(65) 6790-6221 (Phone)
(65) 6791-3697 (Fax)

Saji Gopinath

Regional Engineering College, India ( email )

Calicut
India
91 (0495) 287206 (Phone)
0495-287250 (Fax)

Chandrasekhar Krishnamurti (Contact Author)

Nanyang Business School ( email )

S3-B1B-76 Nanyang Avenue
Nanyang Technological University
Singapore 639798
Republic of Singapore
(65) 790-5702 (Phone)
(65) 791-3697 (Fax)

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