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Catching falling knives: speculating on market overreaction

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  • Colliard, Jean-Edouard

Abstract

Market 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

Suggested Citation

  • Colliard, Jean-Edouard, 2013. "Catching falling knives: speculating on market overreaction," Working Paper Series 1545, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20131545
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    File URL: https://www.ecb.europa.eu//pub/pdf/scpwps/ecbwp1545.pdf
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    Cited by:

    1. Mahata, Ajit & Rai, Anish & Nurujjaman, Md. & Prakash, Om, 2021. "Modeling and analysis of the effect of COVID-19 on the stock price: V and L-shape recovery," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 574(C).
    2. Jonathan Brogaard & Terrence Hendershott & Ryan Riordan, 2014. "High-Frequency Trading and Price Discovery," The Review of Financial Studies, Society for Financial Studies, vol. 27(8), pages 2267-2306.

    More about this item

    Keywords

    high-frequency trading; market crashes; speculation; supply information;
    All these keywords.

    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

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