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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.

Suggested Citation

  • Stefan Nagel, 2012. "Evaporating Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 25(7), pages 2005-2039.
    • Handle: RePEc:oup:rfinst:v:25:y:2012:i:7:p:2005-2039
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    File URL: http://hdl.handle.net/10.1093/rfs/hhs066
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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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