Flow Toxicity and Bank Equity Holdings
55 Pages Posted: 6 Sep 2018
Date Written: August 30, 2018
This paper investigates the market microstructure effects on client firms of equity holdings by relationship banks, i.e., lenders and/or underwriters, prior to the 2008 financial crisis. It intends to shed light on the need for “the Volcker Rule.” We find that banks’ equity holdings of corporate clients reduce flow toxicity and effective spreads surrounding earnings announcements. Such client firms also experience higher 3-day abnormal stock returns and better subsequent one-month stock performance. In contrast, firms with higher holdings by other independent institutional investors do not have robust lower flow toxicity and experience significantly lower abnormal returns during the 3-day and one month windows. The findings suggest that, on average, banks perform valuable market making services in the equity market and are compensated by modest profits.
Keywords: the Volcker Rule, bank market making, flow toxicity, market microstructure, bank equity holdings
JEL Classification: G21, G24, G28, G14, D82
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