TITLE:
Market Making, Liquidity Provision, and Attention Constraints: An Experimental Study
AUTHORS:
Juan F. Cabrera
KEYWORDS:
Limited Attention, Attention Constraints, Market Making, Market Liquidity, Liquidity Provision, Experimental, Behavioral, Microstructure
JOURNAL NAME:
Theoretical Economics Letters,
Vol.7 No.4,
June
16,
2017
ABSTRACT: This paper uses an experimental electronic market to
investigate the effect of limited attention on the market maker’s ability to
provide liquidity and, thus, on aggregate market liquidity. I find that higher
demands on the market maker’s attention worsen her ability to provide liquidity
but do not reduce the aggregate level of market liquidity. This effect is only
significant in less active markets. Furthermore, the aggregate level of market
liquidity remains unaltered across both highly active and inactive markets, suggesting
a reactive strategy by informed traders who step in to compete with market
makers during high information intensity periods when their attention
allocation efforts are compromised. In fact, in markets with a higher
information value, the effect of attention constraints on the liquidity
provision ability of market makers is greater. This implies that informed
traders may not only exploit their informational advantage against uninformed
traders but they may also use it to reap a higher share of liquidity-based
profits. Finally, the market maker’s trading performance measured by her profit
share and ability to manage her inventory worsens when demands on her attention
are greater.