Common Factors in Prices, Order Flows and Liquidity

Abstract:     
How important are cross-stock common factors in the price discovery/liquidity provision process in equity markets? We investigate two aspects of this question for the thirty Dow stocks. First, using principal components and canonical correlation analyses we find that both returns and order flows are characterized by common factors. Commonality in theorder flows explains roughly half of the commonality in returns. Second, we examinevariation and common covariation in various liquidity proxies and market depth (tradeimpact) coefficients. Liquidity proxies such as the bid-ask spread and bid-ask quote sizes exhibit time variation which helps explain time variation in trade impacts. The common factors in these liquidity proxies are relatively small, however.

Number of Pages in PDF File: 31

working papers series