DP12372 Activism, Strategic Trading, and Liquidity

Author(s): Kerry E. Back, Pierre Collin-Dufresne, Vyacheslav Fos, Tao Li, Alexander P. Ljungqvist
Publication Date: October 2017
Keyword(s): activism, continuous time, economic efficiency, Kyle model, liquidity, market depth, price impact, strategic trading
JEL(s): G14, G34
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12372

We analyze dynamic trading by an activist investor who can expend costly effort to affect firm value. We obtain the equilibrium in closed form for a general activism technology, including both binary and continuous outcomes. Variation in parameters can produce either positive or negative relations between market liquidity and economic efficiency, depending on the activism technology and model parameters. Two results that contrast with the previous literature are that (a) the relation between market liquidity and economic efficiency is independent of the activist's initial stake for a broad set of activism technologies and (b) an increase in noise trading can reduce market liquidity, because it increases uncertainty about the activist's trades (the activist trades in the opposite direction of noise traders) and thereby increases information asymmetry about the activist's intentions.