Stock Price Crashes: Role of Slow-Moving Capital
We study the role of various trader types in providing liquidity in spot and futures markets based on complete order-book and transactions data as well as cross-market trader identifiers from the National Stock Exchange of India for a single large stock. During normal times, short-term traders who carry little inventory overnight are the primary intermediaries in both spot and futures markets, and changes in futures prices Granger-cause changes in spot prices. However, during two days of fast crashes, Granger-causality ran both ways. Both crashes were due to large-scale selling by foreign institutional investors in the spot market. Buying by short-term traders and cross-market traders was insufficient to stop the crashes. Mutual funds, patient traders with better trade-execution quality who were initially slow to move in, eventually bought sufficient quantities leading to price recovery in both markets. Our findings suggest that market stability requires the presence of well-capitalized standby liquidity providers.
Previously circulated as "Stock Price Crashes: Role of Capital Constrained Traders." We thank the Centre for Analytical Finance at the Indian School of Business and the National Stock Exchange of India for data. We thank Viral Acharya, Lawrence Glosten, Merrel Hora, Dermot Murphy, Nirmal Mohanty, Todd Pulvino, Ramabhadran Thirumalai, Ravi Varanasi, Vish Viswanathan, Pradeep Yadav, Brian Weller, Roberto Renó, Aleksey Kolokolov, and Jonathan Brogaard for helpful comments. Isacco Baggio, Yakshup Chopra, Nuri Ersahin, Naveen Reddy Gondhi, Caitlin Gorback, Mrinal Mishra, and Roberto Panzica provided valuable research assistance. Special thanks to Rudresh Kunde and Tomasz Wisniewski for data support. Loriana Pelizzon gratefully acknowledges the research support from the Research Center SAFE, funded by the State of Hessen initiative for research LOEWE. All errors are our own. The views expressed in the paper are those of the authors and do not represent the views of AQR Capital Management LLC or the National Bureau of Economic Research.
I acknowledge the financial support of the Norwegian School of Economics (NHH). I also acknowledge the support of Kellogg School of Management, Nothwestern University for providing access to data storage and processing power.