Do designated market makers provide liquidity during downward extreme price movements?

TL;DR

This paper investigates whether designated market makers (DMMs) provide liquidity during extreme downward price movements, revealing that they offer liquidity when selling pressure is concentrated but withdraw when multiple stocks are affected.

Contribution

It introduces a novel methodology to detect extreme price movements and analyzes DMM behavior during these events using a unique dataset with trader classification.

Findings

DMMs provide liquidity during concentrated selling pressure

DMMs withdraw liquidity when multiple stocks are affected

The study offers insights into DMM strategies during market stress

Abstract

We study the trading activity of designated market makers (DMMs) in electronic markets using a unique dataset with audit-trail information on trader classification. DMMs may either adhere to their market-making agreements and offer immediacy during periods of heavy selling pressure, or they might lean-with-the-wind to profit from private information. We test these competing theories during extreme (downward) price movements, which we detect using a novel methodology. We show that DMMs provide liquidity when the selling pressure is concentrated on a single stock, but consume liquidity (leaving liquidity provision to slower traders) when several stocks are affected.