While mutual funds and issue of stocks cause price impact, hedge funds and repurchase of shares decrease this. The doctoral dissertation by Kalle Rinne, M. Sc. (Econ.), studies how demand and provision of immediacy affects the market's functioning and what the roles are of different market parties with regard to provision of immediacy.
Immediacy is indicative of how expensive it is to execute a trade immediately with available sellers, instead of waiting for a suitable counter party to enter the market.
The dissertation comprises five individual essays that examine provision of immediacy from different perspectives. The first essay examines how the imbalance of demand and provision creates price impact that will bring about costs for those who demand immediacy.
Suppliers of immediacy level off this imbalance by taking part in trade when spurred on by the profits from prices returning to their normal level. This leads to a short-term phenomenon of returns reversals; according to the study nearly one-fourth (24%) of stock profits are returned within the following week.
Mutual funds incur losses and hedge funds profit from provision of immediacy
The second essay proves that mutual funds incur losses due to costs brought about by demand for immediacy. The average cost of stock funds is 0.7% a year. These costs explain to a large extent why profits of mutual funds are on average lower than stock market profits.
The third essay shows that in general hedge funds will supply immediacy in the stock markets. The role of hedge funds as a supplier of immediacy is also evident in that the increase in the sum of money managed in hedge funds improves liquidity and decreases the phenomenon of return reversals. Due to this, hedge funds benefit the stock markets.
Issuing of stocks creates demand for and repurchases provide immediacy
The fourth essay examines the effect of price impact on issuing. The price impact caused by stock sales during issuing temporarily lowers the price of stocks, i.e. issuing creates demand for immediacy.
Market activities of investment banks attract new investors into the market lowering the effects of price impact on public offering when compared to rights issues.
The fifth essay shows that repurchase of stocks provides immediacy in the stock markets. Repurchase activity of companies is highest when the price of the stock has fallen due to selling pressure. Therefore, repurchases are beneficial to the stock market and add to the probability that investors will receive a fair price for stocks they sell.
Explore further: In the case of wholesale food distributors, it's all about location
More information: Kalle Rinne, M.Sc. (Econ.), will present his doctoral dissertation Essays on Price Impact and Provision of Immediacy in the subject area of financing for public examination at the Aalto University School of Economics (Chydenia, G112 Hall, 1st floor, Runeberginkatu 22-24) at noon on Friday 25 May 2012.