True Cost of Immediacy

67 Pages Posted: 25 Aug 2020 Last revised: 6 Apr 2022

See all articles by Terrence Hendershott

Terrence Hendershott

University of California, Berkeley - Haas School of Business

Dan Li

Board of Governors of the Federal Reserve System

Dmitry Livdan

University of California, Berkeley

Norman Schuerhoff

Swiss Finance Institute - HEC Lausanne

Multiple version iconThere are 2 versions of this paper

Date Written: August 24, 2020

Abstract

Markets can give a false impression of their liquidity and stability if failed attempts to trade are not accounted for. We quantify this bias by estimating the distribution of investors' reserve prices using data on auctions (bids wanted in competition; BWICs) from the collateralized loan obligation (CLO) market. We show that the true cost of immediacy (TCI) is substantially higher than the observed cost for successful BWICs because trade failures are frequent and failure costs that constitute lost gains from trade are large and correlated with failure rates. The average observed cost across credit quality is 0.04-0.12% while TCI is 0.31-3.79%. TCI is higher in lowerrated CLOs and stressful market conditions when failure rates exceed 50% and failure costs exceed 10%, suggesting substantial market fragility. For these tranches TCI is almost double gains from trade and TCI for sellers with low reserve price is more than 50% higher than the median.

Keywords: Liquidity, bids-wanted-in-competition, collateralized loan obligations, securities auctions, over-the-counter market structure

JEL Classification: G12, G14, G24

Suggested Citation

Hendershott, Terrence J. and Li, Dan and Livdan, Dmitry and Schuerhoff, 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

Board of Governors of the Federal Reserve System ( 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 Schuerhoff (Contact Author)

Swiss Finance Institute - HEC Lausanne ( email )

Chavannes-près-Renens
Switzerland

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