Who supplies liquidity, how and when?

Transcription

1 Who supplies liquidity, how and when? Presentation prepared for the 14th BIS Annual Conference Lucerne, June 215 Bruno Biais, Fany Declerck, Sophie Moinas Toulouse School of Economicc

2 Who supplies liquidity? Old days: specialists, market makers Modern stock markets: prop traders, high frequency traders How? Non immediately executed limit orders? Trade on reversals (Nagel, 212)? Why? Better information/technology (lower adverse selection costs)? Better ability to bear inventory risk? Better connection to markets? When? Does liquidity evaporate when needed? Crisis, small caps Consequences? Shift adverse selection costs to others? Stabilize market by accomodating buying or seling pressure? Profitable? Limits to arbitrage (Shleifer Vishny, 1997, Gromb Vayanos 22)

3 21: Ancient Greek crisis VIX Low volat Crisis Moderate volat Jan-1 Feb-1 Mar-1 Apr-1 May-1 Jun-1 Jul-1 Aug-1 Sep-1 April 23: Grece asks for bailout May 7: June 14: bailout downgrade

4 Euronext members vary in terms of connection speed % of members 18% 16% 14% 12% 1% 8% 6% 4% 2% % [ - 25] ]25-5] ]5-75] ]75-1] ]1-15] ]15-2] ]2-3] ]3-4] ]4-8] ]8-13] ]13-16] ]16-24] ]24-46] Max # messages per second

5 Five categories of members Fast >13 mssg/sec Slow Fast prop trading boutique Prop Other (Dual) Hedge fund or prop trading desk with own member id direct connection to Euronext Broker 37

6 23 French stocks, Euronext Data > 7To = 1, CD Sample of stocks 1 large caps (1 financial, 9 non financial) float between 1,48 and 3,884 million euros 9 mid caps (1 financial, 8 non financial) float between 181 and 96 million euros 4 small caps (non financial) float between 51 and 145 million euros

7 Number of trades per member, stock & day 7 6 limit 5 limit marketable 4 marketable 3 2 marketable 1 limit limit marketable limit marketable fast prop slow prop fast dual slow dual slow brokers Fast trade more, rely more on non immediately executed limit orders Slow prop trade less, rely more on marketable orders

8 25 2 Number of trades per member, stock & day Small cap, before, during and after crisis Pre crisis Crisis Trade more during crisis but same mix limit-market 15 Post crisis 1 5 L M L M L M L M L M L M fast prop slow prop fast dual slow dual slow brokers Crisis => Fast prop traders place more marketable orders But trade less with (non immediately executed) limit orders: reduce this type of liquidity supply

9 Marketable orders Who places these orders? When? Are they consuming liquidity? Are they profitable? Is behaviour different during the crisis?

10 Informational content of marketable orders (M t+2min M t- )/(M t- ) * (sign of take order) fast prop slow prop fast dual slow dual slow brokers All marketable orders have info content, fast similar to others: Around 4 basis points (all impose adverse selection costs on others)

11 Momentum & contrarian Panel A: large caps Panel B: Small & mid caps mn -2 mn -1 mn -1s -1s -5ms 5 ms 1s 5s 1s 3s 1 mn 1 mn 3 2 mn 2 mn 3 5 mn -5 mn -2 mn -1 mn -1s -1s -5ms 5 ms 1s 5s 1s 3s 1 mn 1 mn 3 2 mn 2 mn 3 5 mn fast prop ( obs) slow prop (17261 obs) fast prop (71856 obs) slow prop ( obs) fast dual ( obs) slow dual ( obs) fast dual ( obs) slow dual ( obs) slow brokers (94881 obs) slow brokers (57938 obs) Dual (including fast) & brokers ride momentum: consume liquidity Fast & slow prop contrarian: provide liquidity, also in small caps

12 During crisis Fast prop & slow prop keep supplying liquidity with contrarian marketable orders.1 Pre-crisis.1 Crisis.1 Post-crisis mn -1 mn -1s 1s 1s 1 mn 2 mn 5 mn. -5 mn -1 mn -1s 1s 1s 1 mn 2 mn 5 mn. -5 mn -1 mn -1s 1s 1s 1 mn 2 mn 5 mn Contrast with reduced liquidity supply via passive limit orders

13 Prop marketable orders profitable, not others (M t+2min P t )/(M t- ) * (sign of marketable order) * fast prop slow prop fast dual slow dual slow brokers Liquidity supplying contrarian orders profitable: info content > spread Liquidity consuming momentum orders not profitable

14 Liquidity supplying, contrarian, proprietary marketable orders also profitable during crisis and for small caps small & mid caps large caps.6 Pre-crisis Crisis Post-crisis Pre-crisis Crisis Post-crisis fast prop slow prop fast dual slow dual slow brokers During crisis, prop traders continue to supply liquidity with contrarian marketable orders, which continue to be profitable

15 Limit orders (non immediately executed) Who places these orders? When? Are they profitable? Is behaviour different during the crisis?

16 Adverse selection cost for limit orders: after limit buy order hit, price drops (symmetric for sell) (M t+2min M t- )/(M t- ) * (sign of make order). fast prop slow prop fast dual slow dual slow brokers All limit orders adversely selected, Fast prop less so

17 More adverse selection during crisis & for small caps Fast prop similar to dual before crisis cope better with crisis, especially for large caps small & mid caps large caps. Pre-crisis Crisis Post-crisis Pre-crisis Crisis Post-crisis fast prop slow prop fast others slow others slow brokers Fast prop rely less on limit orders, but avoid losses on these orders

18 # of cancellations & # of updates to less agressive normalized by # of trades Fast prop monitor market & cancel more/update before pricked off Panel A: Update Panel B: Cancel fast prop slow prop fast dual slow dual slow brokers fast prop slow prop fast dual slow dual slow brokers All Crisis All Crisis especially during crisis: reduce A.S cost

19 Conclusion Prop traders, fast or slow, provide liquidity with contrarian marketable orders: inventory bearing capacity => help market absorb shocks, even during crisis => profitable liquidity supply Fast traders provide additional liquidity with non immediately executed limit orders, only fast prop traders do so without making losses Monitor market to cancel & update limit orders => reduce A.S. They have superior technology & incentives to do so

20 Unintended consequences of regulation? MIFID 2: cap ratio of messages to trade => reduce ability of fast traders to cancel/modify limit orders => reduce ability to cope with adverse selection => reduce liquidity supply via passive limit orders Banking regulation: more difficult & costly to conduct prop trading => reduce prop traders ability to help market accomodate liquidity shocks (more limits to arbitrage)

21 Connection speed correlated with throughput.25.2 Microseconds Messaging capacity