US investors are mostly institutional investors. How has the homogeneity of their trading exacerbate the liquidity...

US investors are mostly institutional investors. How has the homogeneity of their trading exacerbate the liquidity crisis in stock market?

Expert Solution

US investors are mostly investors and are homogenous in accessing a market conditions, if a positive news happens all the investors try to buy the stocks at the same time and in sell side only less sellers will be present. This increases the demand of stocks which drives its prices and hence causes increase in volatility and reduces the liquidity. Similarly if there is any negative news, everyone will try to sell at the same time(since all institutional investors will be similarly affected) , which drives the supply and hence causes reduction in price and liquidity on the buy side will be low.

Due to this homogenity in their actions, there will be a liquidity crunch in stock market as a whole. Also such investors have only a limited pool of stocks in their watch list. Such stocks gets traded actively all the time and remaining stocks will have lower volumes which reduces the liquidity of such stocks which are not watched by institutional investors.

Both of these actions due to similar actions of institutional investors causes liquidity crisis in market and when a crisis comes the liquidity problems gets multifold.

jeff jeffy answered 2 years ago

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