Adverse Selection and Liquidity: From Theory to Practice

45 Pages Posted: 30 Aug 2018

See all articles by Albert S. Kyle

Albert S. Kyle

University of Maryland

Anna A. Obizhaeva

New Economic School (NES)

Date Written: June 3, 2018


This paper shows how to map predictions of theoretical models of market microstructure into operational empirical measures of liquidity. A meta-model implies an empirical measure of liquidity, denoted L, which describes various characteristics of trading and funding liquidity such as trading costs, bet sizes, haircuts, and capital requirements. When mapped into existing models of adverse selection, the meta-model also describes precisely how adverse selection shows up in pricing accuracy and resiliency. The meta-model is consistent with models of both block trading and flow trading. It highlights a deep connection between time and adverse selection.

Keywords: market microstructure, invariance, liquidity, adverse selection, market impact, bid-ask spread, bet size, market efficiency, dimensional analysis, leverage neutrality

JEL Classification: G10, G12, G14, G20

Suggested Citation

Kyle, Albert (Pete) S. and Obizhaeva, Anna A., Adverse Selection and Liquidity: From Theory to Practice (June 3, 2018). Available at SSRN: or

Albert (Pete) S. Kyle

University of Maryland ( email )

College Park
College Park, MD 20742
United States

Anna A. Obizhaeva (Contact Author)

New Economic School (NES) ( email )

100A Novaya ul
Moscow, Skolkovo 143026

Register to save articles to
your library


Paper statistics

Abstract Views
PlumX Metrics