The LIX: A Model-Independent Liquidity Index

Abstract

This paper provides a new model-free indicator of liquidity, the so-called LIX index. The computation of the LIX index combines the conic finance theory, which recognizes the two-price economy and is built upon the concept of indices of acceptability, with the option payoff spanning formula of Breeden and Litzenberger. Matching the conic bid and ask prices of the stock with those observed in the market allows us to derive a model-free and unit-less indicator of spot liquidity. Just as the VIX and the SKEW index quantify the volatility and the tail risk perceived by today's investors, the resulting LIX index measures, in a similar market-implied fashion, the liquidity risk.

The maximum likelihood estimation of popular mean-reverting processes applied to model-free liquidity time series indicates that spot liquidity tends to dry up during distress periods whereas, surprisingly, options turn out to be generally more liquid, with some notable exceptions for near-maturity options.

Keywords: spot liquidity, model-free liquidity index, option liquidity surface, conic finance, pre- and post-crisis liquidity

JEL Classification: G10, G110, C580