Nº 20-109: Do Proprietary Traders Provide Liquidity?

Proprietary traders’ role in capital markets has received heightened attention with the debate over the Volcker Rule following the 2008-09 financial crisis. To date, there is little evidence on whether proprietary traders provide or take liquidity and how their behavior evolves over the business cycle. Using a unique dataset of proprietary trading activity, we show that proprietary traders concentrate their trades in a subset of stocks that are liquid to begin with. On average, proprietary traders provide liquidity in their trades, but they do so selectively, in large and liquid stocks, and when intermediary balance sheets are strong. Finally, proprietary traders do not increase their liquidity provision during periods of low returns when liquidity dries up.