Liquidity Derivatives

58 Pages Posted: 13 Sep 2022 Last revised: 28 Mar 2023

See all articles by Matteo Bagnara

Matteo Bagnara

EDHEC Business School - Scientific Portfolio

Ruggero Jappelli

University of Warwick, Warwick Business School; Leibniz Institute for Financial Research SAFE

Date Written: March 28, 2023

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 (March 28, 2023). 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

EDHEC Business School - Scientific Portfolio ( email )

France

Ruggero Jappelli (Contact Author)

University of Warwick, Warwick Business School ( email )

West Midlands, CV4 7AL
United Kingdom

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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