Stock prices incorporate less news before negative events than positive events. Further, informed agents use less price aggressive (limit) orders before negative events and more price aggressive (market) orders before positive events (buy–sell asymmetry). Motivated by these patterns, we model the execution risk that informed agents impose on each other and relate the asymmetry to costly short selling. When investor base is narrow, security borrowing is difficult, or the magnitude of the event is small, buy–sell asymmetry is pronounced and price discovery before negative events is lower. Overall, we show that the strategies of informed traders influence the process of price formation in financial markets, as predicted by theory.

Many stock exchanges choose to reduce market transparency by allowing traders to hide some or all of their order size. We study the costs and benefits of order exposure and test hypotheses regarding hidden order usage using a sample of Euronext-Paris stocks, where hidden orders represent 44% of the sample order volume. Our results support the hypothesis that hidden orders are associated with a decreased probability of full execution and increased average time to completion, and fail to support the alternate hypothesis that order exposure causes defensive traders to withdraw from the market. However, exposing rather than hiding order size increases average execution costs. We assess the extent to which non-displayed size is truly hidden and document that the presence and magnitude of hidden orders can be predicted to a significant, but imperfect, degree based on observable order attributes, firm characteristics, and market conditions. Overall, the results indicate that the option to hide order size is valuable, in particular, to patient traders.

We explore the link between mutual funds and fragility risk in the corporate bond market. We classify a fund’s trading style based on its responses to signals of large dealer inventories. Trading style is persistent and the majority of funds demand liquidity. Notably, a subset of funds earn positive alpha by intentionally supplying liquidity during periods of sustained customer selling (with transitory price effects). Liquidity-supplying funds maintain their relative trading style when facing large outflows and elevated market stress, thus alleviating fragility risk. Our results add nuance to existing evidence that mutual funds pose a threat to market stability.

Bond underwriters, lacking “Greenshoe options” and formal systems to track “flipping” activity, have fewer tools than equity underwriters to manage secondary market order flow uncertainty. We show that bond underwriters respond by selectively “overallocating” some issues to attain net short positions. Overallocations are economically substantive, facilitate the syndicate's price stabilization efforts, and are largely offset in the days after issuance. These issues on average experience more net selling by institutional investors and, despite large syndicate purchases, appreciate less in the secondary market. Thus, overallocation is an observable indicator that underwriters anticipate weakness in net secondary market demand.

Information asymmetry in financial markets relates to the idea that one party to a transaction has better information than the other. Since financial reporting involves the transmission of value relevant enterprise information, we investigate whether the quality of reported earnings can contribute to differentially informed financial market participants. Higher information asymmetry is costly as it increases the adverse selection risk for market participants and lowers liquidity. For a large sample of NYSE and NASDAQ firms, we show that (i) poor earnings quality is significantly and incrementally associated with higher information asymmetry, (ii) earnings quality disproportionately affects information asymmetry for firms with poor information environments, (iii) both innate and discretionary components of earnings quality increase information asymmetry, and (iv) poor earnings quality exacerbates the information asymmetry around earnings announcements. Our results suggest that the standard setters’ efforts to develop accounting standards that improve earnings quality should contribute to a better information environment for market participants and increase stock liquidity.

We study trading costs and dealer behavior in U.S. corporate bond markets from 2006 to 2016. Despite a temporary spike during the financial crisis, average trade execution costs have not increased notably over time. However, dealer capital commitment, turnover, block trade frequency, and average trade size decreased during the financial crisis and thereafter. These declines are attributable to bank‐affiliated dealers, as nonbank dealers have increased their market commitment. Our evidence indicates that liquidity provision in the corporate bond markets is evolving away from the commitment of bank‐affiliated dealer capital to absorb customer imbalances, and that postcrisis banking regulations likely contribute.

We extend the theory of strategic trading around a predictable liquidation by considering the role of market resiliency. Our model predicts that even a monopolist strategic trader improves market quality and increases liquidator proceeds if trades’ temporary price impacts are quickly reversed, and that competition among strategic traders strictly improves market quality. We provide related empirical evidence by studying prices, liquidity, and individual account trading activity around the large and predictable “roll” trades undertaken by a large exchange-traded fund (ETF). The evidence indicates narrower bid-ask spreads, greater order book depth, and improved resiliency on roll dates. We find that a larger number of individual trading accounts provide liquidity on roll dates, and do not find evidence of the systematic use of predatory strategies. On balance, the theory and evidence imply that traders supply liquidity to rather than exploit predictable trades in resilient markets.

Using detailed order handling data, we find that institutional brokers who route more orders to affiliated alternative trading systems (ATSs) are associated with lower execution quality (i.e., lower fill rates and higher implementation shortfall costs). To separate clients’ preference for ATSs from brokers’ routing decisions, we confirm these results for orders where brokers have more order handling discretion, matched broker analysis that accounts for ATS usage, matched child orders that account for client intent, and based on an exogenous constraint on ATS venue choice. Our results suggest that increased transparency of order routing practices will improve execution quality.

We examine the impact of institutional trading on stock resiliency during the financial crisis of 2007–2009. We show that buy-side institutions have different exposure to liquidity factors based on their trading style. Liquidity supplying institutions absorb the long-term order imbalances in the market and are critical to recovery patterns after a liquidity shock. We show that these liquidity suppliers withdraw from risky securities during the crisis and their participation does not recover for an extended period of time. The illiquidity of specific stocks is significantly affected by institutional trading patterns; participation by liquidity supplying institutions can ameliorate illiquidity, while participation by liquidity demanding institutions can exacerbate illiquidity. Our results provide guidance on why some stocks take longer to recover in a crisis.