Implications of Multiple Equilibria in a Short-Term Market with Persistent Liquidity Trading

The objective of this paper is to test implications of Cespa and Vives’ (2015) model in a short-term stock market with persistent liquidity trading. Predictions of the model largely hold in the sample. Findings of the study have important implications for market players and regulators. Firstly, there is return predictability at LIE state. Particularly, during a financial crisis stocks tend to exhibit negative return autocorrelation. Second, volume, order imbalance and its volatility can provide information about investors’ opinion on the fundamental value. Last but not the least, market regulators can elevate price informativeness by improving quality of public information