Stock Market Liquidity: Role of Short-Term and Long-Term Traders

OMI Seminar Series

Using unique trader-identified data from the National Stock Exchange of India, we examine the role of short and long term traders in liquidity provision during normal times and crashes. Short term traders who carry little or no inventory overnight provide liquidity on one side of over 2/3rd of trades. During normal price fluctuations, these traders put in buy orders when prices decline and sell when prices rise, thereby providing liquidity to the market and stabilizing prices. However, during the two fast crash days in our sample, their buying was insufficient to meet the liquidity needs of selling foreign institutions. Inventories of short term traders were high preceding the two crashes, indicating limited capital of short-term liquidity providers. Buying by domestic mutual funds, which have a natural advantage in making a market in the basket of stocks they hold, and infrequent traders led to price recoveries, highlighting the stabilizing role of slow moving market making capital in fast crashes.

Tuesday, May 5, 2015 - 12:30
to 13:30