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A Model of Stochastic Liquidity
Masahiro Watanabe University of Alberta - School of Business June 1, 2008 Yale ICF Working Paper No. 03-18 EFA 2003 Glasgow Annual Conference Paper Abstract: This paper proposes a dynamic multi-security model in which liquidity reflects stochastic variation, persistence, and commonality of underlying information variance. Illiquidity, price-change variance, and trading volume all increase in the size of information. Using high frequency data, I perform structural estimation of the model by Bayesian Markov-Chain Monte-Carlo simulation, with the conditional volatility of underlying information modeled as stochastic volatility or realized volatility controlling for microstructure noise. I find that a Dow stock's liquidity decreases in the size of information about not only itself but also about other Dow stocks, demonstrating a significant cross-sectional effect of information on liquidity.
Keywords: Kyle model, liquidity, stochastic and realized volatility, Bayesian Markov-Chain Monte-Carlo (MCMC), GARCH, trading volume JEL Classifications: G12, G14 Working Paper SeriesDate posted: June 06, 2003 ; Last revised: June 02, 2008Suggested CitationContact Information
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