An Empirical Analysis of Stock and Bond Market Liquidity
Emory University - Department of Finance
Federal Reserve Bank of New York
University of California, Los Angeles (UCLA) - Finance Area; Institute of Global Finance, UNSW Business School
FRB NY Staff Report No. 164
We study the joint time-series of daily liquidity in government bond and stock markets over the period 1991 to 1998. Innovations in liquidity are positively and significantly correlated across stock and bond markets. Further, order imbalances in the stock market impact bond and stock liquidity, even after controlling for order imbalances in the bond market. Both results suggest the existence of a common liquidity factor in stock and bond markets. We consider monetary conditions and mutual fund flows as sources of order flow and as primitive determinants of liquidity. Monetary expansion enhances stock market liquidity during crises. U.S. government bond funds see higher inflows and equity funds see higher outflows during financial crises, and these flows are associated with decreased liquidity in stock and bond markets. Our results establish a link between "macro" liquidity, or money flows, and "micro" or transactions liquidity.
Number of Pages in PDF File: 61
JEL Classification: G10, G14, G23, E52
Date posted: November 1, 2001
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