True Cost of Immediacy

63 Pages Posted: 25 Aug 2020 Last revised: 18 Sep 2020

See all articles by Terrence Hendershott

Terrence Hendershott

University of California, Berkeley - Haas School of Business

Dan Li

Federal Reserve Board

Dmitry Livdan

University of California, Berkeley

Norman Schürhoff

University of Lausanne; Swiss Finance Institute; Centre for Economic Policy Research (CEPR)

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Date Written: August 24, 2020

Abstract

Traditional liquidity measures can provide a false impression of the liquidity and stability of financial market trading. Using data on auctions (bids wanted in competition; BWICs) from the collateralized loan obligation (CLO) market, we show that a standard measure of liquidity, the effective bid-ask spread, dramatically underestimates the true cost of immediacy because it does not account for failed attempts to trade. The true cost of immediacy is substantially higher than the observed costs for successful BWICs. This cost gap is higher in lower-rated CLOs and stressful market conditions when failure rates exceed 50%. Across our 2012-2020 sample period for trades in senior CLOs, the observed cost is four basis points (bps) while the true cost of immediacy is 13bps. In stressful periods, such as the COVID-19 pandemic, for junior tranches the observed cost of trading increases from an average of 12bps to 25bps while the true cost of immediacy increases from less than 3% to almost 15%.

Keywords: Collateralized loan obligations, bids-wanted-in-competition, over-the-counter markets, liquidity, fragility

JEL Classification: G12, G14, G24

Suggested Citation

Hendershott, Terrence J. and Li, Dan and Livdan, Dmitry and Schürhoff, Norman, True Cost of Immediacy (August 24, 2020). Swiss Finance Institute Research Paper No. 20-71, Available at SSRN: https://ssrn.com/abstract=3680035 or http://dx.doi.org/10.2139/ssrn.3680035

Terrence J. Hendershott

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

Dan Li

Federal Reserve Board ( email )

20th and C Streets, NW
Mail Stop 89
Washington, DC 20551
United States

Dmitry Livdan

University of California, Berkeley ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States
(510) 642-4733 (Phone)

Norman Schürhoff (Contact Author)

University of Lausanne ( email )

Extranef 228
CH-1015 Lausanne
Switzerland
+41 (0)21 692 3447 (Phone)
+41 (0)21 692 3435 (Fax)

Swiss Finance Institute ( email )

c/o University of Geneva
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CH-1211 Geneva 4
Switzerland

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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