Papers

The tick size is the minimum price increment by which securities can be quoted. As such, it determines the granularity of the grid over which securities prices take values and is thus an important driver of trading costs. The magnitude of the tick size affects not only the distribution of trading surplus between liquidity demanders and suppliers, but also market quality, the structure of the trading industry and important aspects of a firm’s life such as managerial learning from stock prices, fundamentals information acquisition, and shareholders’ monitoring.

 We show that, consistent with empirical evidence, access to order  flow information allows traders to supply liquidity via contrarian marketable orders. Lack of market transparency can make liquidity demand upward sloping, inducing strategic complementarity and multiple equilibria. Then an initial dearth of liquidity may degenerate into a liquidity rout (as in a "flash crash'') and traders faced with the largest cost of trading are those consuming more liquidity at equilibrium. An increase in order flow transparency and/or in the mass of dealers who are in the market at all times has a positive impact on total welfare.

We show that when a strategic trader splits her orders across several venues, trading repeatedly with noise traders against competitive, risk-neutral market makers, the nature of the equilibrium crucially depends on the relationship between market fragmentation and order flow observability. More fragmentation leads to an equilibrium switch from pure to mixed strategies if not accompanied by a sufficient increase in order flow observability. Additionally, it also allows the insider to leverage her information across multiple platforms, boosting her total expected profits. Finally, and independently of the nature of the equilibrium, more fragmentation improves liquidity and second period price discovery, while worsening price discovery at the first round in the pure strategies equilibrium region.

We document a way in which active markets for corporate control and firm entry and exit can make stock market inefficiencies instrumental to the promotion of economic efficiency. We show that industry level mutual fund flow price pressure has real effects on key economic industry variables. In particular, negative fund flow price pressure is associated with an increase in M&A activity, both within and across industries as well as reduced entry and increased exit in the industries affected.  We also show that funds’ flow induced selling price pressure increases competitiveness and has a modest positive effect on productivity in the year following the event. Our results suggest that forecasting price inefficiency (where noise predicts future returns) can lead to improved allocative efficiency (where prices promote a more efficient use of resources).

We argue that highly complex funds' prospectuses limit the ability of investors to effectively use available information and make informed investment decisions. Measuring textual complexity with the Fog Index, our evidence suggests that low-quality funds manipulate their prospectuses, making them more complex, possibly targeting less sophisticated investors. These investors, in turn, use a less sophisticated asset pricing model to evaluate fund performance, react more aggressively to past winners, and are more likely to be attracted by funds with high marketing costs. Our results suggest that funds with low-complexity prospectuses are more trustworthy, and that funds with high-complexity prospectuses are possibly subject to more severe agency issues.

Free-entry of trading platforms offering technological services to liquidity providers delivers superior liquidity and welfare outcomes vis-à-vis an unregulated monopoly. However, entry can be excessive or insufficient from a welfare point of view. Depending on the extent of the monopolist’s technological services undersupply compared to the first best, a planner can achieve a higher welfare controlling entry or platform fees.

FX volume helps predict next day currency returns and is economically valuable for currency investors. Predictability implies a stronger currency return reversal for currency pairs with abnormally low volume today, and is driven by the component of FX volume unrelated to volatility, illiquidity, and order flow.

Short-termism need not breed informational price inefficiency even when generating beauty contests. We show that when liquidity trading displays persistence, prices reflect average expectations about fundamentals and liquidity trading. Informed investors then engage in “retrospective” learning to reassess inferences (about fundamentals) made during the trading game’s early stages. This behavior introduces strategic complementarities in the use of information and can yield two stable equilibria that can be ranked in terms of liquidity, volatility, and informational efficiency.

Liquidity providers often learn information about an asset from prices of other assets. We show that this generates a self-reinforcing positive relationship between price informativeness and liquidity. This relationship causes liquidity spillovers and is a source of fragility: a small drop in the liquidity of one asset can, through a feedback loop, result in a very large drop in market liquidity and price informativeness (a liquidity crash). This feedback loop provides a new explanation for comovements in liquidity and liquidity dry-ups. It also generates multiple equilibria.

Exchanges sell both trading services and price information. We study how the joint pricing of these products affects price discovery and the distribution of gains from trade in an asset market. A wider dissemination of price information reduces pricing errors and the transfer from liquidity traders to speculators. This effect reduces the fee that speculators are willing to pay for trading. Therefore, to raise its revenue from trading, a for-profit exchange optimally charges a high fee for price information so that only a fraction of speculators buy this information. As a result, price discovery is not as efficient as it would be with free price information. This problem is less severe if the exchange must compensate liquidity traders for a fraction of their losses.

We investigate the dynamics of prices, information, and expectations in a competitive, noisy, dynamic asset pricing equilibrium model with long-term investors. We argue that the fact that prices can score worse or better than consensus opinion in predicting the fundamentals is a product of endogenous short-term speculation. For a given positive level of residual pay-off uncertainty, if liquidity trades display low persistence, rational investors act like market makers and accommodate the order flow and prices are farther away from fundamentals compared to consensus. This defines a “Keynesian” region; the complementary region is “Hayekian” in that rational investors chase the trend and prices are systematically closer to fundamentals than average expectations. The standard case of no residual uncertainty and liquidity trading following a random walk is on the frontier of the two regions and identifies the set of deep parameters for which rational investors abide by Keynes’ dictum of concentrating on an asset “long-term prospects and those only”. The analysis also explains momentum and reversal in stock returns and how accommodation and trend-chasing strategies differ from these phenomena.

Fundamental information resembles in many respects a durable good. Hence, the effects of its incorporation into stock prices depend on who is the agent controlling its flow. Like a durable goods monopolist, a monopolistic analyst selling information inter-temporally competes against herself. This forces her to partially relinquish control over the information flow to traders. Conversely, an insider solves the inter-temporal competition problem through vertical integration, thus exerting tighter control over the information flow. Comparing market patterns I show that a dynamic market where information is provided by an analyst is thicker and more informative than one where an insider trades.

When stakeholder protection is left to the voluntary initiative of managers, relations with social activists may become an effective entrenchment strategy for inefficient CEOs. We thus argue that managerial turnover and firm value are increased when explicit stakeholder protection is introduced so as to deprive incumbent CEOs of activists' support. This finding provides a rationale for the emergence of specialized institutions (social auditors and ethic indexes) that help firms commit to stakeholder protection even in the case of managerial replacement. Our theory also explains a recent trend whereby social activist organizations and institutional shareholders are showing a growing support for each other's agenda.