The World Federation of Exchanges (WFE), the global industry group for CCPs and exchanges, has published a Research Working Paper on the impact of different investor types on liquidity and price formation.
Using timestamped orders and trades data from the Stock Exchange of Thailand (SET), the WFE Research paper studies how different market participants – retail investors, domestic and foreign institutions – influence price formation for different liquidity levels. The paper finds that trading participants in the SET market contribute heterogeneously to price formation, and that liquidity affects the size, but not the relative importance, of their contribution to prices.
Retail investors’ trades are associated with the highest information content for both high- and low-liquidity stocks.
Foreign investors appear to be the second most important contributors to price formation. Interestingly, the analysis shows that trades between foreign and retail traders are the ones that convey most information, hinting that the interaction between two informed categories is beneficial for price formation.
Finally, domestic institutions contribute less to price formation, consistent with them being largely buy-and-hold participants.
Nandini Sukumar, Chief Executive Officer of the WFE, says: “It’s critical to understand how different investor types, especially retail, engage with and contribute to liquidity and price formation in markets today. The WFE is committed to researching and studying the functioning of markets as part of our mandate to contribute to the sum total of knowledge about the vital role that public markets play in the real economy.’’
Pedro Gurrola-Perez, Head of Research at the WFE and one of the authors of the paper, says: “Understanding the role that different types of participants play in the price formation process provides useful information as exchanges seek to continuously improve the liquidity of public markets. While different markets will vary in their individual characteristics, this research is a contribution to such understanding and highlights the importance of attracting a healthy mix of participants to the markets.”
