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Liquidity Providers’ Portfolio Inventory Risk: Frictions and Fragility in Limit Order Markets joint with Vikas Raman and Pradeep Yadav

Wednesday 5 February 2020, 1.00PM to 2.00 pm

Speaker(s): Roman Kozhan (Warwick BS)

Host: Kostas Koufopoulos

Book appointments: 1:1

Abstract: We employ data from a limit order book market to investigate – in the context of Ho and Stoll (1983) – how trading, liquidity provision, and overall market quality in one security are influenced by liquidity providers’ inventory risk exposure to other securities in their portfolios. We first show that the trading of voluntary liquidity providers in today’s electronic limit order book markets is conditioned not just by the risk of their individual stock inventories, but also by their correlated risk exposures in other stocks– their overall portfolio inventory risk. Further, we find that large and correlated portfolio inventories of liquidity providers in limit order book markets not only worsen different measures of market quality – including bid-ask spreads and pricing errors – but also increase the number and likelihood of extreme price movements and transitory jumps in stock returns. We accordingly highlight a significant but often overlooked source of frictions, contagion, and fragility.

Location: A/EW/104

Admission: All welcome