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Evaporating Liquidity

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  • Stefan Nagel

Abstract

The returns of short-term reversal strategies in equity markets can be interpreted as a proxy for the returns from liquidity provision. Using this approach, this article shows that the return from liquidity provision is highly predictable with the VIX index. Expected returns and conditional Sharpe ratios from liquidity provision spike during periods of financial market turmoil. The results point to withdrawal of liquidity supply and an associated increase in the expected returns from liquidity provision, as a main driver behind the evaporation of liquidity during times of financial market turmoil, consistent with theories of liquidity provision by financially constrained intermediaries. The Author 2012. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

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Bibliographic Info

Article provided by Society for Financial Studies in its journal The Review of Financial Studies.

Volume (Year): 25 (2012)
Issue (Month): 7 ()
Pages: 2005-2039

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Handle: RePEc:oup:rfinst:v:25:y:2012:i:7:p:2005-2039

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Citations

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Cited by:
  1. Brogaard, Jonathan & Hendershott, Terrence & Riordan, Ryan, 2013. "High frequency trading and price discovery," Working Paper Series 1602, European Central Bank.
  2. Lasse Heje Pedersen, 2009. "When Everyone Runs for the Exit," NBER Working Papers 15297, National Bureau of Economic Research, Inc.
  3. Chen, Haojun & Maher, Daniela, 2013. "On the predictive role of large futures trades for S&P500 index returns: An analysis of COT data as an informative trading signal," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 27(C), pages 177-201.
  4. Zhi Da & Qianqiu Liu & Ernst Schaumburg, 2011. "Decomposing short-term return reversal," Staff Reports 513, Federal Reserve Bank of New York.

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