Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/154453
Authors: 
Cespa, Giovanni
Vives, Xavier
Year of Publication: 
2017
Series/Report no.: 
ECB Working Paper 2020
Abstract: 
We show that limited dealer participation in the market, coupled with an informational friction resulting from high frequency trading, can induce demand for liquidity to be upward sloping and strategic complementarities in traders' liquidity consumption decisions: traders demand more liquidity when the market becomes less liquid, which in turn makes the market more illiquid, fostering the initial demand hike. This can generate market instability, where an initial dearth of liquidity degenerates into a liquidity rout (as in a flash crash). While in a transparent market, liquidity is increasing in the proportion of high frequency traders, in an opaque market strategic complementarities can make liquidity U-shaped in this proportion as well as in the degree of transparency.
Subjects: 
asymmetric information
flash crash
high frequency trading
market fragmentation
JEL: 
G10
G12
G14
Document Type: 
Working Paper

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