Catching falling knives: speculating on market overreaction

Jean-Edouard Colliard

No 1545, Working Paper Series from European Central Bank

Abstract: Market participants often invest in order to acquire information that pertains to the market itself (e.g. order flow) rather than to fundamentals. This enables them to infer more information from past trades. I show that agents trading on such information, typically high-frequency traders, decrease the likelihood of short-lived mispricings by trading against price pressure. In the long-run however, such countervailing speculation amounts to signal-jamming, slowing down price discovery. These traders insure the market against short-run crashes by "catching falling knives". Higher adverse selection and slower convergence form the "premium" paid by other market participants. JEL Classification: D82, G0, G12, G14

Keywords: high-frequency trading; market crashes; speculation; supply information (search for similar items in EconPapers)
Date: 2013-05
New Economics Papers: this item is included in nep-cta and nep-mst
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