Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/155521 
Year of Publication: 
2016
Series/Report no.: 
CESifo Working Paper No. 6279
Publisher: 
Center for Economic Studies and ifo Institute (CESifo), Munich
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: 
market fragmentation
high frequency trading
flash crash
asymmetric information
JEL: 
G10
G12
G14
Document Type: 
Working Paper
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