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Who supplies liquidity, how and when? Presentation prepared for the 14th BIS Annual Conference Lucerne, June 2015 Bruno Biais, Fany Declerck, Sophie Moinas Toulouse School of Economicc
21

BIAIS Presentation - Bank for International Settlements

Jun 17, 2022

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Page 1: BIAIS Presentation - Bank for International Settlements

Who supplies liquidity, how and when?

Presentation prepared for the 14th BIS Annual Conference Lucerne, June 2015

Bruno Biais, Fany Declerck, Sophie Moinas Toulouse School of Economicc

Page 2: BIAIS Presentation - Bank for International Settlements

Old days: specialists, market makers Modern stock markets: prop traders, high frequency traders How? Non immediately executed limit orders ? Trade on reversals (Nagel, 2012) ? 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 2002)

Who supplies liquidity ?

Page 3: BIAIS Presentation - Bank for International Settlements

0

5

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20

25

30

35

40

45

50

Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10

VIX

Crisis Moderate volat

April 23: Grece asks for bailout

May 7: June 14: bailout downgrade

Low volat

2010: Ancient Greek crisis

Page 4: BIAIS Presentation - Bank for International Settlements

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

[0 - 25] ]25 - 50] ]50 - 75] ]75 -100]

]100 -150]

]150 -200]

]200 -300]

]300 -400]

]400 -800]

]800 -1300]

]1300 -1600]

]1600 -2400]

]2400 -4600]

% of members

Max # messages per second

Euronext members vary in terms of connection speed

Page 5: BIAIS Presentation - Bank for International Settlements

Five categories of members

Fast Slow >1300 mssg/sec 6 22

11 74 37

Prop Other (Dual) Broker

Fast prop trading boutique

Hedge fund or prop trading desk with own member id direct connection to Euronext

Page 6: BIAIS Presentation - Bank for International Settlements

23 French stocks, Euronext Data > 7To = 1,000 CD 10 large caps (1 financial, 9 non financial) float between 1,048 and 3,884 million euros 9 mid caps (1 financial, 8 non financial) float between 181 and 960 million euros 4 small caps (non financial) float between 51 and 145 million euros

Sample of stocks

Page 7: BIAIS Presentation - Bank for International Settlements

Number of trades per member, stock & day

0

10

20

30

40

50

60

70

fast prop slow prop fast dual slow dual slow brokers

limit

marketable

limit marketable limit

marketable

limit marketable

Fast trade more, rely more on non immediately executed limit orders Slow prop trade less, rely more on marketable orders

limit

marketable

Page 8: BIAIS Presentation - Bank for International Settlements

Number of trades per member, stock & day Small cap, before, during and after crisis

0

5

10

15

20

25

fast prop slow prop fast dual slow dual slow brokers

Pre crisis Crisis

Post crisis

L M

Crisis => Fast prop traders place more marketable orders But trade less with (non immediately executed) limit orders: reduce this type of liquidity supply

Trade more during crisis but same mix limit-market

L M

L M

L M

L M

L M

Page 9: BIAIS Presentation - Bank for International Settlements

Marketable orders

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

Page 10: BIAIS Presentation - Bank for International Settlements

Informational content of marketable orders (Mt+2min – Mt-)/(Mt-) * (sign of take order)

All marketable orders have info content, fast similar to others: Around 4 basis points

(all impose adverse selection costs on others)

0.00

0.01

0.01

0.02

0.02

0.03

0.03

0.04

0.04

0.05

0.05

fast prop slow prop fast dual slow dual slow brokers

Page 11: BIAIS Presentation - Bank for International Settlements

Momentum & contrarian

Dual (including fast) & brokers’ ride momentum: consume liquidity Fast & slow prop contrarian: provide liquidity, also in small caps

-0.0010

-0.0005

0.0000

0.0005

0.0010

-5 m

n

-2 m

n

-1 m

n

-10s -1

s

-5m

s 0

5 m

s 1s 5s 10s

30s

1 m

n

1 m

n 30

2 m

n

2 m

n 30

5 m

n

Panel A: large caps

fast prop (585268 obs) slow prop (1070261 obs)

fast dual (1221454 obs) slow dual (872885 obs)

slow brokers (94881 obs)

-0.0010

-0.0005

0.0000

0.0005

0.0010

-5 m

n

-2 m

n

-1 m

n

-10s -1

s

-5m

s 0

5 m

s 1s 5s 10s

30s

1 m

n

1 m

n 30

2 m

n

2 m

n 30

5 m

n

Panel B: Small & mid caps

fast prop (71856 obs) slow prop (135587 obs)

fast dual (213851 obs) slow dual (314854 obs)

slow brokers (57938 obs)

Page 12: BIAIS Presentation - Bank for International Settlements

During crisis Fast prop & slow prop keep supplying liquidity with contrarian marketable orders

-0.0010

-0.0005

0.0000

0.0005

0.0010

-5 m

n

-1 m

n

-1s 0 1s 10s

1 m

n

2 m

n

5 m

n

Pre-crisis

-0.0010

-0.0005

0.0000

0.0005

0.0010

-5 m

n

-1 m

n

-1s 0 1s 10s

1 m

n

2 m

n

5 m

n

Crisis

-0.0010

-0.0005

0.0000

0.0005

0.0010

-5 m

n

-1 m

n

-1s 0 1s 10s

1 m

n

2 m

n

5 m

n

Post-crisis

Contrast with reduced liquidity supply via passive limit orders

Page 13: BIAIS Presentation - Bank for International Settlements

Prop marketable orders profitable, not others (Mt+2min – Pt)/(Mt-) * (sign of marketable order) * 100

-0.0400

-0.0300

-0.0200

-0.0100

0.0000

0.0100

0.0200

fast prop slow prop fast dual slow dual slow brokers

Liquidity supplying contrarian orders profitable: info content > spread Liquidity consuming momentum orders not profitable

Page 14: BIAIS Presentation - Bank for International Settlements

-0.0010

-0.0008

-0.0006

-0.0004

-0.0002

0.0000

0.0002

0.0004

0.0006Pre-crisis Crisis Post-crisis Pre-crisis Crisis Post-crisis

small & mid caps large caps

fast prop

slow prop

fast dual

slow dual

slow brokers

Liquidity supplying, contrarian, proprietary marketable orders also profitable during crisis and for small caps

During crisis, prop traders continue to supply liquidity with contrarian marketable orders, which continue to be profitable

Page 15: BIAIS Presentation - Bank for International Settlements

Limit orders (non immediately executed)

Who places these orders? When?

Are they profitable? Is behaviour different during the crisis?

Page 16: BIAIS Presentation - Bank for International Settlements

All limit orders adversely selected, Fast prop less so

Adverse selection cost for limit orders: after limit buy order hit, price drops (symmetric for sell)

(Mt+2min – Mt-)/(Mt-) * (sign of make order)

-0.0500

-0.0450

-0.0400

-0.0350

-0.0300

-0.0250

-0.0200

-0.0150

-0.0100

-0.0050

0.0000fast prop slow prop fast dual slow dual slow brokers

Page 17: BIAIS Presentation - Bank for International Settlements

More adverse selection during crisis & for small caps Fast prop similar to dual before crisis

cope better with crisis, especially for large caps

-0.1100

-0.1000

-0.0900

-0.0800

-0.0700

-0.0600

-0.0500

-0.0400

-0.0300

-0.0200

-0.0100

0.0000Pre-crisis Crisis Post-crisis Pre-crisis Crisis Post-crisis

small & mid caps large caps

fast prop

slow prop

fast others

slow others

slow brokers

Fast prop rely less on limit orders, but avoid losses on these orders

Page 18: BIAIS Presentation - Bank for International Settlements

# of cancellations & # of updates to less agressive normalized by # of trades

especially during crisis: reduce A.S cost

Fast prop monitor market & cancel more/update before pricked off

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2

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14

16

fast prop slow prop fast dual slow dual slow brokers

Panel B: Cancel

All Crisis

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10

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14

16

fast prop slow prop fast dual slow dual slow brokers

Panel A: Update

All Crisis

Page 19: BIAIS Presentation - Bank for International Settlements

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

Conclusion

Page 20: BIAIS Presentation - Bank for International Settlements

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)

Unintended consequences of regulation ?

Page 21: BIAIS Presentation - Bank for International Settlements

Connection speed correlated with throughput

0

0.00005

0.0001

0.00015

0.0002

0.00025

0 50 100 150 200 250 300

Mic

rose

cond

s

Messaging capacity