Strategic Liquidity Provision and Extreme Volatility Spikes

We test competing theories of liquidity dynamics during extreme volatility spikes (EVSs). We find that liquidity providers strategically allow for price pressures and are compensated from correcting pricing errors. As a result, liquidity provision intensifies towards the end of a typical EVS. This goes counter to a widespread concern that market making constraints cause liquidity to deteriorate as EVSs develop. The prevailing limit order book dynamics during EVSs are in line with Weill’s (2007) socially beneficial equilibrium.

Keywords: extreme price movements, price pressures, strategic liquidity provision, extreme volatility spikes

JEL Classification: G10, G14

Suggested Citation: Suggested Citation

Brogaard, Jonathan and Sokolov, Konstantin and Zhang, Jiang, Strategic Liquidity Provision and Extreme Volatility Spikes (September 26, 2020). Management Science, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3700218 or http://dx.doi.org/10.2139/ssrn.3700218