Terrence Hendershott, University of California-Berkeley
Saad Khan, HEC Montréal
Ryan Riordan, Queen's University
Abstract: Payment for order flow (PFOF) impacts competition through potential agency issues inorder routing and execution. Regulation prevents off-exchange internalization in options, soexchanges offer price-improvement auctions. Auctions receive large price improvement andhave lower trading costs and market maker revenues. PFOF wholesalers are often designatedmarket makers (DMMs) on exchanges. Exchange market share, non-auction market makerrevenues, and auction price improvement are higher for PFOF DMMs. PFOF DMMs with lowerrecent execution quality are more likely to run auctions. Our results suggest PFOF and optionsmarket structure better promote competition in auctions than in non-auctions.
Discussant: Andriy Shkilko, Wilfrid Laurier University
Christian Heyerdahl-Larsen, BI Norwegian Business School
Preetesh Kantak, Indiana University
Abstract: We study how disagreement on both factor and stock-specific risk exposures across many investors and securities impacts asset prices. Our theoretical analyses predict that disagreement about factor dynamics drives larger flows into portfolios that are more exposed to the factors. These concentrated bets on the factor lead to higher volatility and reduced diversification benefits. We then test these predictions using a novel empirical setting – exchange-traded funds (ETFs). We find that when factor disagreement rises, ETFs that mimic the factor see increased flows, higher forward-looking volatility risk, and a higher forward-looking correlation among the stocks in the ETF.
Abstract: We construct novel measures of net and gross short covering to examine when short sellers exit positions. We find that idiosyncratic limits to arbitrage, such as adverse stock price movements, volatility, and equity lending fees, are associated with significantly higher position closures. In contrast, we find little evidence that aggregate limits to arbitrage, including VIX, funding liquidity, and market liquidity, affect short covering. Short covering predicts future returns in the wrong direction, but only if it is induced by limits to arbitrage, consistent with the hypothesis that short sellers are forced to exit too early. It is also associated with lower price efficiency, higher future anomaly returns, and better performance of other informed traders. These results show that firm-level limits to arbitrage are important determinants of trading behavior and future returns.
