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Institutional Liquidity Costs, Internalized Retail Trade Imbalances, and the Cross Section of Stock Returns

Published online by Cambridge University Press:  23 January 2025

Yashar H. Barardehi Open the ORCID record for Yashar H. Barardehi [Opens in a new window] ,
Dan Bernhardt ,
Zhi Da  and
Mitch Warachka
Yashar H. Barardehi*
Affiliation:
Chapman University Argyros College of Business & Economics
Dan Bernhardt
Affiliation:
University of Illinois Department of Economics University of Warwick Department of Economics danber@illinois.edu
Zhi Da
Affiliation:
University of Notre Dame Mendoza College of Business zda@nd.edu
Mitch Warachka
Affiliation:
Chapman University Argyros College of Business & Economics warachka@chapman.edu
*
barardehi@chapman.edu (corresponding author)
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Abstract

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Order flow segmentation prevents direct interactions between U.S. retail and institutional investors. Using the imbalance in observable internalized retail trades, we show wholesalers use retail flow to provide liquidity to institutional investors, especially when liquidity is scarce. Our institutional liquidity cost ($ ILC $) measures average absolute retail trade imbalances, positing that institutions holding stocks with greater such averages more often resort to the expensive wholesaler-provided liquidity. $ ILC $ is correlated with expected institutional price impacts. Unlike existing illiquidity measures, $ ILC $ has economically meaningful relations with institutional holding horizons and yields annualized liquidity premia of 2.7%–3.2% post-2010, even after excluding microcap stocks.

Information

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 60 , Issue 8 , December 2025 , pp. 3826 - 3865
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (http://creativecommons.org/licenses/by/4.0), which permits unrestricted re-use, distribution and reproduction, provided the original article is properly cited.
Copyright
© The Author(s), 2025. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

This paper subsumes “Internalized Retail Order Imbalances and Institutional Liquidity Demand.” We thank two anonymous referees, Yakov Amihud, James Angel, Robert Battalio (discussant), Azi Ben-Rephael, Hendrik Bessembinder, John Campbell, Amy Edwards, Greg Eaton, Tom Ernst, Thierry Foucault (the editor), Terry Hendershot, Björn Hagströmer, Steven Ho, Paul Irvine, Charles Jones, Alla Kammerdiner (discussant), Mete Kilic (discussant), Pete Kyle, Marc Lipson, Liang Ma, Albert Menkveld, Josh Mollner (discussant), Dermot Murphy, Shawn O’Donoghue, Michael Pagano, Cameron Pfiffer, John Ritter, Thomas Ruchti, Gideon Saar, Andriy Shkilko, Chester Spatt, Michael Sullivan, Jose Tessada, Andrew Zhang, and seminar and conference participants at Cal Poly–SLO, the California Corporate Finance Conference, the Microstructure Exchange, Microstructure Seminars – Asia-Pacific, 2022 Santiago Finance Workshop, 2022 FMA Annual Meetings, 2023 Finance Down Under, the 10th Conference on Financial Market Regulation, 2023 Stern Microstructure Conference, and the University of Nevada at Las Vegas for helpful comments.

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