Stock Liquidity and Algorithmic Market Making During the COVID-19 Crisis

As the role of designated market makers in liquidity supply has diminished over time, algorithmic traders (ATs) have stepped up to fill that gap in modern equity markets. Prompted by concerns of fragility introduced by such voluntary market making, we examine ATs’ liquidity-provision role during the COVID-19 crisis. Amidst the turmoil as overall market liquidity declined, we find that ATs did not (disproportionately) withdraw liquidity supply. Stocks with the highest algorithmic trading (AT) activity experienced lower liquidity reduction compared to stocks with low AT activity, although profits from market making in high AT stocks fell more. High AT stocks did not experience greater reduction in either competition for liquidity provision or price improvements than low AT stocks. Multiple tests indicate that high AT activity did not associate with any greater deterioration in price efficiency vis-a-vis low AT stocks. Stocks in industries hardest hit by COVID-19 did not see any less AT competition for liquidity supply or price efficiency than stocks in the least affected ones. Overall, our results allay some recent concerns that the current levels of AT have made markets more susceptible to liquidity withdrawal in times of crises.