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ecbwp1545

ecbwp1545

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Published by: caitlynharvey on May 13, 2013
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07/10/2013

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Working PaPer SerieS
no 1545 / may 2013
CatChing Falling kniveSSPeCulating on marketoverreaCtion
  Jean-Edouard Colliard
In 2013 all ECB publicationsfeature a motif taken fromthe €5 banknote.
note: 
This Working Paper should not be reportedas representing the views of the European CentralBank (ECB). The views expressed are those of the
authors and do not necessarily reect those of the ECB.
 
© European Central Bank, 2013Address
Kaiserstrasse 29, 60311 Frankfurt am Main, Germany
Postal address
Postfach 16 03 19, 60066 Frankfurt am Main, Germany
Telephone
+49 69 1344 0
Internet
http://www.ecb.europa.eu
Fax
+49 69 1344 6000All rights reserved.
ISSN
1725-2806 (online)
EU Catalogue No
QB-AR-13-042-EN-N (online)Any reproduction, publication and reprint in the form of a different publication, whether printed or produced electronically, in wholeor in part, is permitted only with the explicit written authorisation of the ECB or the authors.This paper can be downloaded without charge from http://www.ecb.europa.eu or from the Social Science Research Network electroniclibrary at http://ssrn.com/abstract_id=2163080.Information on all of the papers published in the ECB Working Paper Series can be found on the ECB’s website,http://www.ecb.
Acknowledgements
 The author is grateful to Shmuel Baruch, Christophe Chamley, Amil Dasgupta, Gabrielle Demange, Thierry Foucault, Alfred Galichon,Peter Homann, Joel Peress, Jean-Charles Rochet, Emmeline Travers, Dimitri Vayanos, an anonymous referee of the ECB Working paper series, participants to the 2012 NBER Microstructure Meeting, the 1st European Retail Investment Conference - Doctoral Consortium,seminars at the London School of Economics and the Paris School of Economics, for helpful comments and suggestions. Part of thisresearch project was undertaken while I was visiting the London School of Economics, whose hospitality is truly appreciated. The
views expressed in this paper are the author’s and do not necessarily reect those of the European Central Bank or the Eurosystem.
Jean-Edouard Colliard
 
Abstract
Market participants often invest in order to acquire information that pertains to themarket itself (e.g. order flow) rather than to fundamentals. This enables them to infermore information from past trades. I show that agents trading on such information,typically high-frequency traders, decrease the likelihood of short-lived mispricings bytrading against price pressure. In the long-run however, such countervailing speculationamounts to signal-jamming, slowing down price discovery. These traders insure themarket against short-run crashes by “catching falling knives”. Higher adverse selectionand slower convergence form the “premium” paid by other market participants.
Journal of Economic Literature 
Classification Number: D82, G0, G12, G14.
Keywords 
: market crashes, speculation, supply information, high-frequency trading.
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