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Noise as Information for Illiquidity

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  • GRACE XING HU
  • JUN PAN
  • JIANG WANG

Abstract

We propose a market‐wide liquidity measure by exploiting the connection between the amount of arbitrage capital in the market and observed “noise” in U.S. Treasury bonds—the shortage of arbitrage capital allows yields to deviate more freely from the curve, resulting in more noise in prices. Our noise measure captures episodes of liquidity crises of different origins across the financial market, providing information beyond existing liquidity proxies. Moreover, as a priced risk factor, it helps to explain cross‐sectional returns on hedge funds and currency carry trades, both known to be sensitive to the general liquidity conditions of the market.

Suggested Citation

  • Grace Xing Hu & Jun Pan & Jiang Wang, 2013. "Noise as Information for Illiquidity," Journal of Finance, American Finance Association, vol. 68(6), pages 2341-2382, December.
    • Handle: RePEc:bla:jfinan:v:68:y:2013:i:6:p:2341-2382
    DOI: 10.1111/jofi.12083
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    JEL classification:

    • G0 - Financial Economics - - General

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