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
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
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 ?
0
5
10
15
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
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
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
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
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
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
Marketable orders
Who places these orders? When? Are they consuming liquidity? Are they profitable? Is behaviour different during the crisis?
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
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)
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
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
-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
Limit orders (non immediately executed)
Who places these orders? When?
Are they profitable? Is behaviour different during the crisis?
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
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
# 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
4
6
8
10
12
14
16
fast prop slow prop fast dual slow dual slow brokers
Panel B: Cancel
All Crisis
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2
4
6
8
10
12
14
16
fast prop slow prop fast dual slow dual slow brokers
Panel A: Update
All Crisis
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
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 ?
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