Often, this blog provides novel research that may not include the straightforward trading strategy, yet it is an interesting insight for portfolio managers, risk managers, investors or traders. Novel research of Brogaard et al. (2020) examines the crucial role of market makers during extreme price movements. According to the authors and the past literature, there are two competing theories of how the extreme price movements end, and both are related to the market makers. It is the constrained liquidity provision theory and the strategic liquidity provision. This research tests and explains these competing theories, with findings that are in line with the strategic liquidity provision. The results can be found particularly interesting during extreme price movements because the paper has shown that firstly, liquidity providers scale back and only interfere later. Market makers utilize price pressures in stressful times in a profitable way, since they profit from subsequent reversals.
Authors: Jonathan Brogaard, Konstantin Sokolov and Jiang Zhang
Title: How do Extreme Price Movements End?