Short-Term Reversals and the Efficiency of Liquidity Provision

We present a model where the magnitude of return reversals depend on the number of informed investors as well as the number of active but uninformed investors that play a market making role. Consistent with the model, the magnitude of return reversals is temporarily higher following declines in the number of active institutional investors. By using stock price declines over the previous one and two quarters as instruments for unanticipated declines in active investors, we get much stronger reversals. We also show that the magnitude of the reversals as well as their relation to prior stock price declines are lower in the post-2000 period, which is consistent with active uniformed investors (e.g., high frequency traders) reacting more quickly to changes in the number of informed investors in the more recent period.

This event is an Erasmus Finance Seminar. The Erasmus Finance Seminar series brings prominent researchers in Finance from all over the world to Rotterdam.