Events

Economics Seminar

Author:

• Dan Bernhardt
  University of Illinois

• Yashar Heydari Barardehi
  University of Illinois

• Ryan J. Davies
  Babson college

Decimalization, regulatory changes, and technological advances have transformed stock markets, shrinking bid-ask spreads, driving down depth, and causing institutional investors to employ order-splitting algorithms. We develop a stock-specific measure of market activity for this environment by calculating the time it takes for sequences of trades each worth a fixed percent of a firm's market capitalization to execute-shorter durations indicate more active markets. As market activity rises so do trade sizes and signed order imbalances; but price impacts fall for small and mid-sized firms; and for large firms, price impacts exhibit a single-peaked relationship with market activity. Much of the variation in market activity reflects endogenous variation in liquidity provision/ consumption; and not information arrival. We instrument for this endogeneity and uncover predictable, uniform trading costs/market activity relationships across stocks-with trading costs falling by 5{8 basis points as instrumented market activity rises. Using these trading cost measures as illiquidity measures in an augmented CAPM, we find that they outperform standard measures (bid-ask spreads, Amihud's measure), and that liquidity premia have not declined.