Price pressures

Hendershott, Terrence

doi:10.1016/j.jfineco.2014.08.001

Price pressures

2014-12-01

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Hendershott, Terrence

A

Albert J. Menkveld *

DOI：10.1016/j.jfineco.2014.08.001

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We study price pressures, i.e., deviations from the efficient price due to risk-averse intermediaries supplying liquidity to asynchronously arriving investors. Empirically, New York Stock Exchange intermediary data reveals economically large price pressures, 0.49% on average with a half life of 0.92 days. Theoretically, a simple dynamic inventory model captures an intermediary's use of price pressure to mean-revert inventory. She trades off revenue loss due to price pressure against price risk associated with staying in a nonzero inventory state. The closed-form solution identifies the intermediary's risk aversion and the investors' private value distribution from the observed time series patterns of prices and inventories. These parameters imply a relative social cost due to price pressure, a deviation from constrained Pareto efficiency, of approximately 10% of the cost of immediacy. (C) 2014 Elsevier B.V. All rights reserved.

Keyword:

Liquidity

Inventory risk

Intermediary

Volatility

Price pressures

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