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Multivariate Semiparametric Modelling of Market Illiquidity: Trends, Dynamics, and Cross-Country Connectedness

Author

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  • Hafner, C. M.
  • Linton, O. B.
  • Wang, L.

Abstract

We develop a multivariate semiparametric model of market illiquidity that separates asset-specific, smoothly varying seasonal trends from short-run dynamics and cross-market spillovers. A parsimonious portfolio specification accommodates large systems by allowing each asset’s liquidity to depend on its own history and a small number of cross-sectional liquidity indices. We propose estimation by local linear smoothing and generalized method of moments and establish asymptotic theory for both fixed and increasing cross-sectional dimensions. Nonparametric trend estimation generally enters the first-order distribution of the dynamic parameter estimators. We construct Neyman-orthogonal moments that eliminate this first-order effect and simplify inference. Estimation relies on conditional moment restrictions rather than a parametric innovation distribution and accommodates time-varying second moments. We also develop forecast error variance decompositions and connectedness measures, showing how changing second moments generate time-varying connected-ness even when the dynamic coefficients are constant. An application to daily Amihud illiquidity measures for 18 country exchange-traded funds over 2005–2026 documents pronounced weekday seasonality, persistent cross-country heterogeneity, and substantial liquidity spillovers. The United States is the leading net transmitter of liquidity shocks, and aggregate connectedness increases markedly during major episodes of financial stress.

Suggested Citation

  • Hafner, C. M. & Linton, O. B. & Wang, L., 2026. "Multivariate Semiparametric Modelling of Market Illiquidity: Trends, Dynamics, and Cross-Country Connectedness," Cambridge Working Papers in Economics 2569, Faculty of Economics, University of Cambridge.
    • Handle: RePEc:cam:camdae:2569
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    References listed on IDEAS

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    JEL classification:

    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics

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