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Market Price of Trading Liquidity Risk and Market Depth

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  • Masaaki Kijima
  • Christopher Ting

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 for not only to 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.

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  • Masaaki Kijima & Christopher Ting, 2019. "Market Price of Trading Liquidity Risk and Market Depth," Papers 1912.04565, arXiv.org.
    • Handle: RePEc:arx:papers:1912.04565
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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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