Working Paper: NBER ID: w31127
Authors: Manoj Dalvi; Prachi Deuskar; Lawrence R. Glosten; Ravi Jagannathan
Abstract: We identify different roles traders play using data with trader identities for all transactions in SENSEX-index stocks on the Bombay Stock Exchange from January 2005 to December 2011. Individual day traders (IDT) are identified as “noise traders”, who play an important role in the market microstructure literature. We measure the impact of their activity on market liquidity and trading of other market participants. IDT contribute 10% to volume while losing 3.2 bp (73% of the half-spread) on average on trades with others, including proprietary day traders (PDT), the primary intraday-liquidity providers, and longer-term traders. While we find some evidence that supports learning among IDT about their own ability and about how to trade, they continue to participate in the market even after losing for a long period. Instrumental variable regressions show that IDT activity reduces bid ask spread and increases intra-day volatility and total volume traded. The volume traded by PDT and the number of PDT active in the market also increase, but PDT profitability stays unchanged with increased IDT activity. This pattern is consistent with competition among PDT. Our results highlight the importance of IDT’s presence in lubricating financial markets.
Keywords: Day Traders; Market Liquidity; Noise Traders; Bid-Ask Spread
JEL Codes: G14; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| IDT activity (Y20) | bid-ask spread (D44) |
| IDT activity (Y20) | trading volume (G15) |
| IDT activity (Y20) | intraday volatility (C58) |
| IDT profit (O39) | bid-ask spread (D44) |
| IDT activity (Y20) | competition among proprietary day traders (PDT) (D41) |