Ion Lucas Saru, Vrije Universiteit Amsterdam (Job Market Seminar)

"The Cross-Section of Price Efficiency"

Abstract

Inventory management by market makers can result in quoted prices deviating from unobserved fundamental prices. In a setting where prices have a factor structure, optimal inventory management implies that pricing errors of different securities are positively correlated if they load on the same risk factors. Using a state space model, I obtain estimates of 1-minute pricing errors for a panel of 1500 US stocks for the period 2016–2022. Daily cross-sectional regressions of pricing error correlations reveal that pricing error correlations increase in the similarity of factor betas. Investigating the role of liquidity demand in addition to liquidity supply, my results show that ETF flows are associated with higher pricing error correlations.

Contact person: Anders Rahbek