Towards a better understanding of liquidity, trading behavior, and stock returns: Three essays in market microstructure

In the first essay, I study the relation between market liquidity and intraday stock returns. In the intraday context, a momentum-reversal return pattern is observed by comparing the post returns of past winners and past losers that are generated through high-frequency transaction data. The empirical study also shows that in the reversal past winners underperform past losers even though investors still prefer to buy past winners and sell past losers. The explanation for these phenomena is that in the momentum phase there are relatively few limit orders and the market maker charges a high premium to compensate his inventory risk. Later when sufficient limit orders arise in the reversal phase, the market maker can switch to this inexpensive liquidity source and thus reduce his premium.;In the second essay, I examine the difference in liquidity between NYSE-listed U.S. and non-U.S. stocks. I construct a size-matched U.S. stock and a volume-matched U.S. stock for each non-U.S. stock and compare the Kyle's lambda and spread between non-U.S. stocks and their U.S. matches. The empirical results show that the average Kyle's lambda and the average bid-ask spread of non-U.S. stocks are significantly larger than those of size-matched U.S. stocks. When non-U.S. stocks are compared with volume-matched U.S. stocks, the difference in spread width remains significant, although the magnitude of difference decreases. In contrast, the Kyle's lambda difference between non-U.S. stocks and volume-matched U.S. stocks virtually disappears.;In the third essay, I present a rational microstructure model in which informed traders have private information on multi-dimensional uncertainties and herd behavior could possibly occur. In the herd phase, informed traders choose to trade in the same direction regardless of their private signals. I find that there exists a transition phase between the normal phase and the herd phase. The market enters the transition phase when some informed traders' expectation on the risky asset value is within the bid-ask spread. In the transition phase, market liquidity deteriorates, marked by a larger spread and stronger price impact power of incoming orders.