Market Liquidity as Dynamic Factors
ECARES, Universite Libre de Bruxelles
Université Libre de Bruxelles - Solvay Brussels School of Economics and Management
Université Libre de Bruxelles (ULB) - Solvay Brussels School of Economics and Management
Vlerick Business School
January 1, 2009
We study market liquidity via daily close relative spreads and daily traded volumes in a sample of 426 S&P500 constituents recorded over the years 2004-2006, a period of "normal" liquidity conditions. We use recent results on the Generalized Dynamic Factor Model (GDFM) with block structure to provide a sound definition of unobservable market liquidity and to assess the complementarity of those two liquidity measures. The advantage of defining market liquidity as dynamic factors is that, contrary to other definitions that can be found in the literature, it tackles time dependence and commonness at the same time, without making any restrictive assumptions on the underlying data generating process. Both relative spread and volume in the dataset under study appear to be driven by the same one-dimensional common shocks, which therefore naturally qualify as the unobservable market liquidity shocks.
Number of Pages in PDF File: 21
Keywords: Commonality, liquidity, equities, factor models, block structure
JEL Classification: C33, C51, G10
Date posted: February 2, 2009 ; Last revised: November 1, 2009
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