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Measuring, Forecasting and Explaining Time Varying Liquidity in the Stock Market

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  • Robert F. Engle
  • Joe Lange

Abstract

The paper proposes a new measure, VNET, of market liquidity which directly measures the depth of the market. The measure is constructed from the excess volume of buys or sells during a market event defined by a price movement. As this measure varies over time, it can be forecast and explained. Using TORQ data, it is found that market depth varies positively but less than proportionally with past volume and negatively with the number of transactions. Both findings suggest that over time high volumes are associated with an influx of informed traders and reduce market liquidity. High expected volatility as measured by the ACD model of Engle and Russell (1995) and wide spreads both reduce expected depth. If the asymmetric trades are transacted in shorter than expected times, the costs will be greater giving an estimate of the value of patience.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6129.

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Date of creation: Aug 1997
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Handle: RePEc:nbr:nberwo:6129

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  1. Copeland, Thomas E & Galai, Dan, 1983. " Information Effects on the Bid-Ask Spread," Journal of Finance, American Finance Association, American Finance Association, vol. 38(5), pages 1457-69, December.
  2. Harris, Lawrence, 1987. "Transaction Data Tests of the Mixture of Distributions Hypothesis," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 22(02), pages 127-141, June.
  3. Ho, Thomas & Stoll, Hans R., 1981. "Optimal dealer pricing under transactions and return uncertainty," Journal of Financial Economics, Elsevier, Elsevier, vol. 9(1), pages 47-73, March.
  4. Anat R. Admati, Paul Pfleiderer, 1988. "A Theory of Intraday Patterns: Volume and Price Variability," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 1(1), pages 3-40.
  5. O'Hara, Maureen & Oldfield, George S., 1986. "The Microeconomics of Market Making," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 21(04), pages 361-376, December.
  6. Glosten, Lawrence R, 1987. " Components of the Bid-Ask Spread and the Statistical Properties of Transaction Prices," Journal of Finance, American Finance Association, American Finance Association, vol. 42(5), pages 1293-1307, December.
  7. Foster, F Douglas & Viswanathan, S, 1993. " Variations in Trading Volume, Return Volatility, and Trading Costs: Evidence on Recent Price Formation Models," Journal of Finance, American Finance Association, American Finance Association, vol. 48(1), pages 187-211, March.
  8. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, Econometric Society, vol. 53(6), pages 1315-35, November.
  9. Lee, Charles M C & Ready, Mark J, 1991. " Inferring Trade Direction from Intraday Data," Journal of Finance, American Finance Association, American Finance Association, vol. 46(2), pages 733-46, June.
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Citations

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Cited by:
  1. Ghysels, Eric & Gourieroux, Christian & Jasiak, Joann, 2004. "Stochastic volatility duration models," Journal of Econometrics, Elsevier, Elsevier, vol. 119(2), pages 413-433, April.
  2. Engle, Robert F. & Patton, Andrew J., 2004. "Impacts of trades in an error-correction model of quote prices," Journal of Financial Markets, Elsevier, Elsevier, vol. 7(1), pages 1-25, January.
  3. Jun Muranaga, 1999. "Dynamics of Market Liquidity of Japanese Stocks: An Analysis of Tick-by-Tick Data of the Tokyo Stock Exchange," CGFS Papers chapters, Bank for International Settlements, in: Bank for International Settlements (ed.), Market Liquidity: Research Findings and Selected Policy Implications, volume 11, pages 1-25 Bank for International Settlements.
  4. Toni Gravelle, 1999. "Liquidity of the Government of Canada Securities Market: Stylised Facts and Some Market Microstructure Comparisons to the United States Treasury Market," CGFS Papers chapters, Bank for International Settlements, in: Bank for International Settlements (ed.), Market Liquidity: Research Findings and Selected Policy Implications, volume 11, pages 1-37 Bank for International Settlements.
  5. Georges Dionne & Pierre Duchesne & Maria Pacurar, 2005. "Intraday Value at Risk (IVaR) Using Tick-by-Tick Data with Application to the Toronto Stock Exchange," Cahiers de recherche, CIRPEE 0533, CIRPEE.
  6. Michael J. Fleming, 2001. "Measuring treasury market liquidity," Staff Reports, Federal Reserve Bank of New York 133, Federal Reserve Bank of New York.
  7. Alfonso Dufour & Robert F Engle, 2000. "The ACD Model: Predictability of the Time Between Concecutive Trades," ICMA Centre Discussion Papers in Finance, Henley Business School, Reading University icma-dp2000-05, Henley Business School, Reading University.
  8. Nikolaus Hautsch, 2002. "Modelling Intraday Trading Activity Using Box-Cox-ACD Models," CoFE Discussion Paper, Center of Finance and Econometrics, University of Konstanz 02-05, Center of Finance and Econometrics, University of Konstanz.
  9. Robert F. Engle & Asger Lunde, 2003. "Trades and Quotes: A Bivariate Point Process," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 1(2), pages 159-188.
  10. Kutas, Gábor & Végh, Richárd, 2005. "A Budapest Likviditási Mérték bevezetéséről. A magyar részvények likviditásának összehasonlító elemzése a budapesti, a varsói és a londoni értéktőzsdéken
    [Introduction of the Bu
    ," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(7), pages 686-711.
  11. Persaud, Avinash, 2002. "Liquidity Black Holes: And Why Modern Financial Regulation in Developed Countries is making Short-Term Capital Flows to Developing Countries Even More Volatile," Working Paper Series, World Institute for Development Economic Research (UNU-WIDER) UNU-WIDER Research Paper , World Institute for Development Economic Research (UNU-WIDER).

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