Disposition Sales and Stock Market Liquidity
I examine the impact of the V-shaped disposition effect, which results in uninformed sales when investors realize large gains and losses. Adverse selection risk is reduced in the presence of more uninformed sales. I show in a model that market makers should post tighter bid-ask spreads and quote prices that are less sensitive to sales. Using stocks with merger and acquisition announcements, which increase the magnitude of investors' unrealized gains or losses and trigger disposition sales in the post-announcement period, I find evidence supporting the predictions.