L4 - Liquidity Flashcards
inside trading
advantage:
- insiders indirectly reveal the info. they have in the prices
- without insiders time to know this info is actually longer
disadvantage:
- they take adv. i.e. take transaction and make gain
- extracting rent from other investors
higher risk of transaction at beginning (you increase price such to prevent insiders to gain profit)
liquidity cost is higher in the morning
liquidity function
it is impossible to infer changes on global liquidity based solely on immediacy cost and depth
Liquidity changes whenever:
- spread or depth move in opposite direction
- one of them changes and other remains constant
need to study both together
Liquidity function
supply function
AC (n) = average cost function
unit cost of investor willing to BUY nr- of shares
ASK PRICE
AR(n) = average revenue function
= unit revenue of SELLING determined volume of shares
BID PRICE
LF = AC(n) - AR(n) / m
(midpoint)
L(n) = LB (n) + LS (n)
LB (n) = relative cost of buying -DEMAND
LS(n) = relative cost of selling - SUPPLY
Liquidity function
new function
completely characterises the cost of liquidity of any given asset
single measure able to capture all dimensions associated with liquidity costs
estimation employs a superior set of info. than more traditional measures
all info. available in open LOB is necessary for calculation
–> hence this measure well-suited for markets driven orders
Problem :
maximal 9 shares?
limited amount of shares
not by time since its a specific moment it doesn´t give you time evolution
market needs minimum agreement between the amount of shares between B/A otherwise doeasn´t close pre-openingof the market
minimum agreement during pre-opening between S/D
equilibrium otherwise, once open the market volatility increases (high loss/gain)
solution =
1) calculate function by pice levels
2) calculate function by percentage
Liquidity function
Empirical study 1
5 stocks
info about five best levels of prices at selling/ buying orders over all assets in each instant
for each level and market side
- info about best price
- volume of shares outstanding (Depht)
- number of orders which supports such volume
Liquidity function
Empirical study 1
LF graph for ANCESA
- time, book%, cost of liquidity
initially one takes the LF for each of the stock at every instant
summarise results by taking the mean of normalised LF for each 15min
if no modification in LOB during this quarter, one takes the values of past instan (prev. quarter)
LF includes different percentage:
- at 100% (more volume) shape is stronger (less flatter)
LF is flat at beginning but has more shape at end (more shape as % increases)
but u-shape day evolution
marketcap not only comes from high volume bu also high prices
Empirical study 1
plotting all individual stock LF:
LF (graphs) for each stock
3 different time slots (morning, midday, end)
GLS regression function
speed LF curve - higher spread as % increase
less liquid
LF increases as % of LOB increases
start = size matters (LC is higher the lower the market value of company) not true for rest of the day
slope =
suggests variation in volume needed to move the spread differential
function: alpha + level + time (15min)
- relative to alpha LC is higher both at start and end
- difference are always higher at start than end
evidence of significant L shape for information cost (inside trading)
- less clear evidence reported for biggest market cap (telefonica) only coeff. are smaller (less impact), not many discrepancy (small negative as well as positive coefficient) only in the end significant
empirical study 2
order book - volatility
order book characteristics
volume-volatility relation
show:
changes of number of trades (vol) and price at different levels given by
–> slope of order book (v shape)
–> high at low levels, flatters at higher levels
–> related to volatility of assets
volatility relates to
–> slope of the order book
empirical study 3
changes in distribution of LOB - behaviour of market participants
change in LOB structure relates to aggregate composition of market participants
LOB modified because:
- random departure about general consensus on bid/ask price (alpha coeff)
- impact of exogenous shocks (arrival of new info to market) (beta coeff.)
model suitable for studying changes in market population through:
- evolution of average B/A prices
- dispersion of distribution (magnitude/peak)
Liquidity wrap-up
variables affecting liquidity:
- positive: volume and trading volumen
- negative: volatility and price
but liquidity not just an attribute of a single asset
individual liquidity measures co-movements with each other
(financial crisis - correlation)
not a single variable behind liquidity
most important measures: depth and spread, but have to be analysed together
liquidity intraday has u-form, but though yeas it has decreased (algo and elect. trading?)
liquidity has common factors that affects the stocks
(liquidity of market = stocks, intra-market, bond-market) how it affects rest of market
Spread
The bid-ask spread is essentially the difference:
a) the highest price that a buyer is willing to pay
b) the lowest price that a seller is willing to accept.
The spread is the transaction cost.
Price takers buy at the ask price and sell at the bid
but the market maker buys at the bid price and sells at the ask price.
The bid represents demand and the ask represents supply for an asset.
investors are willing to buy (price takers) hence look at supply (ask price) if it wants to buy but bid price if it wants to sell
Liquidity function
Empirical study 1
average liquidity cost
table
liquidity cost looking at: - liquidity function - RSP - Depth all in terms of %
liquidity cost increases in % of LOB
largest stock is most liquid asset and smallest stock less liquid
liquidity cost increase for all stocks SIMILAR in:
1% to 25% as from 25% to 100%
–> increase in LC changes very rapidly moving away from the 25%
relative Spread systematically overvalues LC (increases as % increases)
depth increases as % increase
