Market Liquidity and Heterogeneity in the Investor Decision Cycle

Richard Bookstaber (), Michael D. Foley () and Brian F. Tivnan ()
Additional contact information
Richard Bookstaber: Office of Financial Research
Michael D. Foley: University of Vermont
Brian F. Tivnan: MITRE Corporation

No 15-03, Working Papers from Office of Financial Research, US Department of the Treasury

Abstract: During liquidity shocks such as occur when margin calls force the liquidation of leveraged positions, there is a widening disparity between the reaction speed of the liquidity demanders and the liquidity providers. Those who are forced to sell typically must take action within the span of a day, while those who are providing liquidity do not face similar urgency. Indeed, the flurry of activity and increased volatility of prices during the liquidity shocks might actually reduce the speed with which many liquidity providers come to the market. To analyze these dynamics, we build upon previous agent-based models of financial markets to develop an order-book model with heterogeneity in trader decision cycles. The model demonstrates an adherence to important stylized facts such as a leptokurtic distribution of returns, decay of autocorrelations over moderate to long time lags, and clustering volatility. We show that the heterogeneity in decision cycles can increase the severity of market shocks, and even absent a shock can have notable effects on the stochastic properties of market prices.

Keywords: Liquidity (search for similar items in EconPapers)
Pages: 25 pages
Date: 2015-03-10
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Citations: View citations in EconPapers (3)

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