Liquidity is generally viewed as a positive characteristic of a traded asset in positive net supply. Ceteris paribus, the higher liquidity of a given asset should be reflected in a higher price or a lower required return. This issue is of particular interest if the same asset is traded in multiple markets. In this setting, apart from the effect of liquidity on pricing in each market, there is t...

This paper discusses how to introduce liquidity into the well known mean-variance framework of portfolio selection using a representative sample of Spanish equity portfolios. Either by estimating mean-variance liquidity constrained frontiers or directly estimating optimal portfolios for alternative levels of risk aversion and preference for liquidity, we obtain strong effects of liquidity on op...

Given the cross-sectional and temporal variation in their liquidity, emerging equity markets provide an ideal setting to examine the impact of liquidity on expected returns. Our main liquidity measure is a transformation of the proportion of zero daily firm returns, averaged over the month. We find that it significantly predicts future returns, whereas alternative measures such as turnover do n...

Financial crises are often characterized by sharp reductions in liquidity followed by cascades of falling prices. Researchers are making progress in work to understand the levels of liquidity on a daily basis, but understanding the vulnerability of liquidity to market shocks remains a challenge. We develop an agent-based model with the objective of evaluating the market dynamics that lead the m...

This paper examines how hedge funds manage their market risk according to changes in aggregate liquidity conditions. Using a large sample of equity-oriented hedge funds during the period of 1994–2008, we find strong evidence that hedge-fund managers possess the ability to time market liquidity at both the style category level and the individual fund level. They increase (decrease) their portfol...

The paper develops a model to study the optimal choice of the central bank haircut policy. In the presence of uncertainties regrading liquidity needs and asset prices, there is a trade-off between providing liquidity to constrained agents and controlling the abundance of liquidity in the economy. The choice of the haircut involves balancing impacts on the liquidity positions of agents with diff...

In light of the recent regulatory changes and the increase in cash reserves after the financial crisis of 2007-08, we examine the determinants of cash levels and the effects of excess cash on bank’s business policies, for both listed and unlisted banks. As for the determinants, we find that larger, more profitable, more capitalized, and more diversified banks hold less cash. As for bank’s polic...

Competition among stock exchanges has increased dramatically over the last decade. To attract trading volume, most exchanges introduced makertaker fees, an incentive scheme that rewards liquidity suppliers and charges liquidity demanders. Using a change in fees on the Toronto Stock Exchange, we analyze how the breakdown of trading fees between liquidity demanders and suppliers affects market ou...

We study the determination of liquidity provision in the single-name credit default swap (CDS) market as measured by the number of distinct dealers providing quotes. We find that liquidity is concentrated among large obligors and those near the investment-grade/speculative-grade cutoff. Consistent with endogenous liquidity provision by informed financial institutions, more liquidity is associat...

We model financial market liquidity as provided by financially constrained arbitrageurs. Market liquidity increases with the level of arbitrage capital, i.e., internal and external capital arbitrageurs can access frictionlessly. We show that liquidity dry-ups follow periods of low returns of arbitrageurs’ risky investment opportunities, and that liquidity is correlated across markets. A welfare...