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Market Price Of Trading Liquidity Risk And Market Depth

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  • MASAAKI KIJIMA

    (School of Informatics and Data Science, Hiroshima University, 1-4-1, Kagamiyama, Higashi-Hiroshima 739-8527, Japan)

  • CHRISTOPHER TING

    (School of Informatics and Data Science, Hiroshima University, 1-4-1, Kagamiyama, Higashi-Hiroshima 739-8527, Japan)

Abstract

Price impact of a trade is an important element in pre-trade and post-trade analyses. We introduce a framework to analyze the market price of liquidity risk, which allows us to derive an inhomogeneous Bernoulli ordinary differential equation. We obtain two closed form solutions, one of which reproduces the linear function of the order flow in Kyle (1985) for informed traders. However, when traders are not as asymmetrically informed, an S-shape function of the order flow is obtained. We perform an empirical intra-day analysis on Nikkei futures to quantify the price impact of order flow and compare our results with industry’s heuristic price impact functions. Our model of order flow yields a rich framework to not only estimate the liquidity risk parameters, but also to provide a plausible cause of why volatility and correlation are stochastic in nature. Finally, we find that the market depth encapsulates the market price of liquidity risk.

Suggested Citation

  • Masaaki Kijima & Christopher Ting, 2019. "Market Price Of Trading Liquidity Risk And Market Depth," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 22(08), pages 1-36, December.
    • Handle: RePEc:wsi:ijtafx:v:22:y:2019:i:08:n:s0219024919500456
    DOI: 10.1142/S0219024919500456
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    References listed on IDEAS

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    Cited by:

    1. Samuel Tabot Enow, 2023. "Stock Market Liquidity during Periods of Distress and its Implications: Evidence from International Financial Markets," International Journal of Economics and Financial Issues, Econjournals, vol. 13(1), pages 1-6, January.

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