21 Pages Posted: 2 Feb 2009 Last revised: 1 Nov 2009
Date Written: 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.
Keywords: Commonality, liquidity, equities, factor models, block structure
JEL Classification: C33, C51, G10
Suggested Citation: Suggested Citation
Hallin, Marc and Pirotte, Hugues and Mathias, Charles and Veredas, David, Market Liquidity as Dynamic Factors (January 1, 2009). Available at SSRN: https://ssrn.com/abstract=1336223 or http://dx.doi.org/10.2139/ssrn.1336223