Catching falling knives: speculating on market overreaction
AbstractMarket participants often invest in order to acquire information that pertains to the market itself (e.g. order flow) rather than to fundamentals. This enables them to infer more information from past trades. I show that agents trading on such information, typically high-frequency traders, decrease the likelihood of short-lived mispricings by trading against price pressure. In the long-run however, such countervailing speculation amounts to signal-jamming, slowing down price discovery. These traders insure the market against short-run crashes by "catching falling knives". Higher adverse selection and slower convergence form the "premium" paid by other market participants. JEL Classification: D82, G0, G12, G14.
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Bibliographic InfoPaper provided by European Central Bank in its series Working Paper Series with number 1545.
Date of creation: May 2013
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Find related papers by JEL classification:
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- G0 - Financial Economics - - General
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-08-23 (All new papers)
- NEP-CTA-2013-08-23 (Contract Theory & Applications)
- NEP-MST-2013-08-23 (Market Microstructure)
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- Brogaard, Jonathan & Hendershott, Terrence & Riordan, Ryan, 2013. "High frequency trading and price discovery," Working Paper Series 1602, European Central Bank.
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