What Drives Intraday Reversal? Illiquidity or Liquidity Oversupply?

73 Pages Posted: 27 Feb 2021 Last revised: 24 Jan 2022

See all articles by Junqing Kang

Junqing Kang

Sun Yat-sen University (SYSU) - Lingnan (University) College

Shen Lin

Tianjin University - College of Management and Economics; PBCSF, Tsinghua University

Xiong Xiong

College of Management and Economics and China Center for Social Computing and Analytics

Multiple version iconThere are 2 versions of this paper

Date Written: October 12, 2021

Abstract

Previous studies of the U.S. market regard short-term reversal as compensation for liquidity provision. However, we find that intraday reversal has no significant dependence on stock liquidity in the Chinese market. Hence, based on a stylized framework, we propose an alternative explanation: irrational uninformed liquidity providers, who underestimate the information component in the equilibrium price due to physiological anchoring, trade against previous price movement, which generates an opposing price pressure. The empirical results confirm this explanation of liquidity oversupply (from irrational uninformed liquidity providers). The negative correlation between previous intraday returns and future returns in the Chinese market is reversed once we extend the holding period. This indicates that reversal is a pricing error due to excessive liquidity provision from uninformed retail traders instead of a price correction from a temporary price concession due to a lack of liquidity.

Keywords: Intraday reversal, liquidity, Chinese market

JEL Classification: D82, G12, G14, G41

Suggested Citation

Kang, Junqing and Lin, Shen and Xiong, Xiong, What Drives Intraday Reversal? Illiquidity or Liquidity Oversupply? (October 12, 2021). Available at SSRN: https://ssrn.com/abstract=3756630 or http://dx.doi.org/10.2139/ssrn.3756630

Junqing Kang

Sun Yat-sen University (SYSU) - Lingnan (University) College ( email )

135 Xingang Xi Road
Guangzhou, Guangzhou 510275
China

Shen Lin (Contact Author)

Tianjin University - College of Management and Economics ( email )

NO.92 Weijin Road
Nankai District
Tianjin, 300072
China

PBCSF, Tsinghua University ( email )

No. 43, Chengdu Road
Haidian District
Beijing 100083
China

Xiong Xiong

College of Management and Economics and China Center for Social Computing and Analytics ( email )

92, Weijin Road
Nankai District
Tianjin, Tianjin 300072
China

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