Liquidity Flashcards
What are 3 sources of illiquidity?
- Search friction for a counterparty.
- Bid-ask spread.
- Price impact.
What are the three types of priority rules w.r.t oder execution?
- Price Priority: Best priced order executes first.
- Time Priority: First entered trade executes first.
- Size Priority: Larger gets executed first.
What are the two components of the bid-ask spread?
- Permanent component to compensate for cost of doing business.
- Adverse-Selection Component to compensate for the uncertainty and asymmetric information.
Where does the trading risk for the market maker come from?
They do not research the fundamental value of securities, but trade with people who do.
What does the Glosten and Milgrom Model of the Bid-Ask spread tell us about security value in the long-run?
That all the information is eventually revealed to reflect the true price.
How does Amihud define Price Impact illiquidity?
Average daily absolute return over daily volatility.
What do Chan and Lakonishok find about the price impact of large investment managers?
Positive price impact of buys and negative price impact of sales.
What is the effect on trading costs of increased tracking error acceptance?
A Higher tracking error reduces the number of needed trade and so reduces the total trading cost.
What is the relationship between returns and liquidity?
There is an inverse relationship after controlling for Beta, Size, past returns, etc.
In the Glosten and Milgrom model, what is the formula for the bid-ask spread?
(Val. High - Val. Low)*[P(Val. High | Sell) - P(Val. High | Buy)]
What is the formula for P(Val. High | Sell)?
What is the formula for P(Val. High | Buy)?
