Who Supplies Liquidity, and When?

63 Pages Posted: 15 Aug 2018

See all articles by Sida Li

Sida Li

University of Illinois at Urbana-Champaign

Xin Wang

Nanyang Technological University (NTU) - Division of Banking & Finance

Mao Ye

University of Illinois at Urbana-Champaign; National Bureau of Economic Research (NBER)

Date Written: August 14, 2018

Abstract

We incorporate discrete tick size and allow non-high-frequency traders (non-HFTs) to supply liquidity in the framework of Budish, Cramton, and Shim (2015). When adverse selection risk is low or tick size is large, the bid-ask spread is typically below one tick, and HFTs dominate liquidity supply. In other situations, non-HFTs dominate liquidity supply by undercutting HFTs, because supplying liquidity to HFTs is always less costly than demanding liquidity from HFTs. A small tick size improves liquidity, but also leads to more mini-flash crashes. The cancellation-to-trade ratio, a popular proxy for HFTs, can have a negative correlation with HFTs’ activity. Our model provides one explanation of flash crashes, and predicts when and where flash crashes are more likely to occur.

JEL Classification: G10, G20

Suggested Citation

Li, Sida and Wang, Xin and Ye, Mao, Who Supplies Liquidity, and When? (August 14, 2018). Available at SSRN: https://ssrn.com/abstract=3231166 or http://dx.doi.org/10.2139/ssrn.3231166

Sida Li

University of Illinois at Urbana-Champaign ( email )

601 E John St
Champaign, IL 61820
United States

Xin Wang

Nanyang Technological University (NTU) - Division of Banking & Finance ( email )

S3-B1B-76 Nanyang Avenue
Singapore, 639798
Singapore
+6593816646 (Phone)

HOME PAGE: http://https://www.financexinwang.com/

Mao Ye (Contact Author)

University of Illinois at Urbana-Champaign ( email )

406 Wohlers
1206 South 6th Street
Champaign, IL 61820
United States
2172440474 (Phone)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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