Price pressures

Terrence Hendershott and Albert Menkveld

Journal of Financial Economics, 2014, vol. 114, issue 3, 405-423

Abstract: We study price pressures, i.e., deviations from the efficient price due to risk-averse intermediaries supplying liquidity to asynchronously arriving investors. Empirically, New York Stock Exchange intermediary data reveals economically large price pressures, 0.49% on average with a half life of 0.92 days. Theoretically, a simple dynamic inventory model captures an intermediary׳s use of price pressure to mean-revert inventory. She trades off revenue loss due to price pressure against price risk associated with staying in a nonzero inventory state. The closed-form solution identifies the intermediary׳s risk aversion and the investors׳ private value distribution from the observed time series patterns of prices and inventories. These parameters imply a relative social cost due to price pressure, a deviation from constrained Pareto efficiency, of approximately 10% of the cost of immediacy.

Keywords: Liquidity; Inventory risk; Intermediary; Volatility (search for similar items in EconPapers)
JEL-codes: D53 D61 G12 G14 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (22)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:114:y:2014:i:3:p:405-423

DOI: 10.1016/j.jfineco.2014.08.001

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