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Reprint of: Market liquidity in the financial crisis: The role of liquidity commonality and flight-to-quality

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  • Rösch, Christoph G.
  • Kaserer, Christoph

Abstract

We examine the dynamics and the drivers of market liquidity during the financial crisis, using a unique volume-weighted spread measure. According to the literature we find that market liquidity is impaired when stock markets decline, implying a positive relation between market and liquidity risk. Moreover, this relationship is the stronger the deeper one digs into the order book. Even more interestingly, this paper sheds further light on so far puzzling features of market liquidity: liquidity commonality and flight-to-quality. We show that liquidity commonality varies over time, increases during market downturns, peaks at major crisis events and becomes weaker the deeper we look into the limit order book. Consistent with recent theoretical models that argue for a spiral effect between the financial sector’s funding liquidity and an asset’s market liquidity, we find that funding liquidity tightness induces an increase in liquidity commonality which then leads to market-wide liquidity dry-ups. Therefore our findings corroborate the view that market liquidity can be a driving force for financial contagion. Finally, we show that there is a positive relationship between credit risk and liquidity risk, i.e., there is a spread between liquidity costs of high and low credit quality stocks, and that in times of increased market uncertainty the impact of credit risk on liquidity risk intensifies. This corroborates the existence of a flight-to-quality or flight-to-liquidity phenomenon also on the stock markets.

Suggested Citation

  • Rösch, Christoph G. & Kaserer, Christoph, 2014. "Reprint of: Market liquidity in the financial crisis: The role of liquidity commonality and flight-to-quality," Journal of Banking & Finance, Elsevier, vol. 45(C), pages 152-170.
  • Handle: RePEc:eee:jbfina:v:45:y:2014:i:c:p:152-170
    DOI: 10.1016/j.jbankfin.2014.06.010
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    Cited by:

    1. Castagneto-Gissey, G. & Nivorozhkin, E., 2016. "No contagion from Russia toward global equity markets after the 2014 international sanctions," Economic Analysis and Policy, Elsevier, vol. 52(C), pages 79-98.
    2. repec:eee:finsta:v:31:y:2017:i:c:p:62-80 is not listed on IDEAS
    3. Sensoy, Ahmet, 2016. "Commonality in liquidity: Effects of monetary policy and macroeconomic announcements," Finance Research Letters, Elsevier, vol. 16(C), pages 125-131.
    4. repec:eee:finmar:v:38:y:2018:i:c:p:14-38 is not listed on IDEAS

    More about this item

    Keywords

    Financial crisis; Liquidity costs; Liquidity commonality; Market liquidity; Flight-to-liquidity; Flight-to-quality; Xetra liquidity measure (XLM);

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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