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Market Liquidity and Heterogeneity in the Investor Decision Cycle

Author

Listed:
  • Richard Bookstaber

    (Office of Financial Research)

  • Michael D. Foley

    (University of Vermont)

  • Brian F. Tivnan

    (MITRE Corporation)

Abstract

During liquidity shocks such as occur when margin calls force the liquidation of leveraged positions, there is a widening disparity between the reaction speed of the liquidity demanders and the liquidity providers. Those who are forced to sell typically must take action within the span of a day, while those who are providing liquidity do not face similar urgency. Indeed, the flurry of activity and increased volatility of prices during the liquidity shocks might actually reduce the speed with which many liquidity providers come to the market. To analyze these dynamics, we build upon previous agent-based models of financial markets to develop an order-book model with heterogeneity in trader decision cycles. The model demonstrates an adherence to important stylized facts such as a leptokurtic distribution of returns, decay of autocorrelations over moderate to long time lags, and clustering volatility. We show that the heterogeneity in decision cycles can increase the severity of market shocks, and even absent a shock can have notable effects on the stochastic properties of market prices.

Suggested Citation

  • Richard Bookstaber & Michael D. Foley & Brian F. Tivnan, 2015. "Market Liquidity and Heterogeneity in the Investor Decision Cycle," Working Papers 15-03, Office of Financial Research, US Department of the Treasury.
    • Handle: RePEc:ofr:wpaper:15-03
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    File URL: https://www.financialresearch.gov/working-papers/files/OFRwp-2015-03_Market-Liquidity-and-Heterogeneity-in-Investor-Decision-Cycle.pdf
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    References listed on IDEAS

    as
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    Cited by:

    1. Mark D. Flood & John C. Liechty & Thomas Piontek, 2015. "Systemwide Commonalities in Market Liquidity," Working Papers 15-11, Office of Financial Research, US Department of the Treasury, revised 14 Dec 2016.
    2. Donovan Platt & Tim Gebbie, 2016. "Can Agent-Based Models Probe Market Microstructure?," Papers 1611.08510, arXiv.org, revised Aug 2017.
    3. Karen Braun-Munzinger & Zijun Liu & Arthur Turrell, 2016. "An agent-based model of dynamics in corporate bond trading," Bank of England Staff Working Paper series 592, Bank of England.

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