Liquidity Derivatives

55 Pages Posted: 13 Sep 2022

See all articles by Matteo Bagnara

Matteo Bagnara

Leibniz Institute for Financial Research SAFE; Goethe University Frankfurt

Ruggero Jappelli

Goethe University, Frankfurt; Leibniz Institute for Financial Research SAFE

Date Written: September 12, 2022

Abstract

It is well established that investors price market liquidity risk. Yet, there exists no financial claim contingent on liquidity. We propose a contract to hedge uncertainty over future transaction costs, detailing potential buyers and sellers. Introducing liquidity derivatives in Brunnermeier and Pedersen (2009) improves financial stability by mitigating liquidity spirals. We simulate liquidity option prices for a panel of NYSE stocks spanning 2000 to 2020 by fitting a stochastic process to their bid-ask spreads. These contracts reduce the exposure to liquidity factors. Their prices provide a novel illiquidity measure refllecting cross-sectional commonalities. Finally, stock returns significantly spread along simulated prices.

Keywords: Asset Pricing, Market Liquidity, Liquidity Risk

JEL Classification: G12, G13, G17

Suggested Citation

Bagnara, Matteo and Jappelli, Ruggero, Liquidity Derivatives (September 12, 2022). SAFE Working Paper No. 358, 2022, Available at SSRN: https://ssrn.com/abstract=4216669 or http://dx.doi.org/10.2139/ssrn.4216669

Matteo Bagnara

Leibniz Institute for Financial Research SAFE ( email )

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Goethe University Frankfurt ( email )

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Ruggero Jappelli (Contact Author)

Goethe University, Frankfurt ( email )

Mertonstrasse 17-25
Frankfurt am Main, D-60325
Germany

Leibniz Institute for Financial Research SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

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