Reaction of the Italian Stock Exchange to Exogenous and Endogenous Shocks: The Echo of the Sub-Prime Crisis and the Introduction of 'Book Profondo'

Abstract

The purpose of the paper is to find empirical evidence of how Italian investors reacted (emotionally?) to some relevant exogenous and endogenous events affecting the Italian Stock Exchange (ISE) during the summer 2007: the sub-prime crisis, the ISE merger with the London Stock Exchange (LSE) and the introduction of Book Profondo (BP). In particular we try to shed light on the reaction of some liquidity and volatility indicators, analyzing different time frames and controlling for some firm-specific features (market capitalization and beta).We study the whole set of stocks listed on the ISE and traded on the MTA equity market, during the six months period, going from the 15th of May 2007 to the 15th of November 2007. We consider tick by tick data for 275 shares. The high frequency of our data allows us to run regressions on panel data with different time frames: every 30minutes (high frequency frame), every 150 minutes (intraday frame) and daily. The econometric methodology adds information on the determinants of stock liquidity. In fact, existing literature on the field seldom uses panel data as we do.Our preliminary findings, on the high frequency time frame, prove evidence that Italian investors clearly perceived the sub prime crisis firsts echoes and promptly reacted, but rationally and not emotionally. In fact we may argue that big informed traders (banks) immediately understood that the lack of liquidity emerging in the interbank deposit market was a serious signal of what it was going to happen. Consequently they undertook clearly stock inventory management strategies. More over, the introduction of BP, which increased the level of pre-trade transparency, is proved to transfer some key liquidity-volatility interconnections from large cap, to medium and small cap transactions.