Market Maker Inventories and Liquidity

[ASusilovic]

Market Maker Inventories and Liquidity
Terrence Hendershott
Pamela C. Moulton
Mark S. Seasholes*
May 9, 2007


Abstract
Traditional microstructure models predict that market makers’ inventory positions do not
impact liquidity (the effective cost of trading). Models with limited market maker riskbearing
capacity predict that larger inventories negatively impact overall liquidity and the
effect is greater for more volatile stocks. Using 11 years of NYSE specialists' inventory
data, this paper tests these theoretical predictions. We find that larger inventory positions
lead to lower liquidity both at the market level and at the market maker’s firm level. We
also find that the impact of inventories is larger for the liquidity of high-volatility stocks
and for smaller market making firms. Finally, we confirm a prediction of models both
with and without limited risk-bearing capacity: Inventory positions affect the relative
liquidity for stock buyers versus sellers.

http://www.fma.org/Orlando/Papers/CapConstraints_and_Liq.pdf

 

[nazzdack]

Quote from ASusilovic:
.....11 years of NYSE specialists' inventory
data, this paper tests these theoretical predictions.

1) 1994 to 2004. That's ancient history.
2) Do the authors take derivative and hedge-related trading into account?
3) The chart on page-37 could be more "relevant" if it were overlayed against the S&P-500.
4) 38 pages! Thanks for almost curing me of my insomnia.

 

[ASusilovic]

Quote from nazzdack:

1) 1994 to 2004. That's ancient history.
2) Do the authors take derivative and hedge-related trading into account?
3) The chart on page-37 could be more "relevant" if it were overlayed against the S&P-500.
4) 38 pages! Thanks for almost curing me of my insomnia.

Good morning !

 

[Martinghoul]

I like this paper... Somewhat counterintuitive conclusion, so will need to read a bit more carefully. Thx!