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Measuring, Forecasting and Explaining Time Varying Liquidity in the Stock Market

  • Robert F. Engle
  • Joe Lange

The paper proposes a new measure, VNET, of market liquidity which directly measures the depth of the market. The measure is constructed from the excess volume of buys or sells during a market event defined by a price movement. As this measure varies over time, it can be forecast and explained. Using TORQ data, it is found that market depth varies positively but less than proportionally with past volume and negatively with the number of transactions. Both findings suggest that over time high volumes are associated with an influx of informed traders and reduce market liquidity. High expected volatility as measured by the ACD model of Engle and Russell (1995) and wide spreads both reduce expected depth. If the asymmetric trades are transacted in shorter than expected times, the costs will be greater giving an estimate of the value of patience.

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File URL: http://www.nber.org/papers/w6129.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6129.

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Date of creation: Aug 1997
Date of revision:
Handle: RePEc:nbr:nberwo:6129
Note: AP
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  1. Foster, F Douglas & Viswanathan, S, 1993. " Variations in Trading Volume, Return Volatility, and Trading Costs: Evidence on Recent Price Formation Models," Journal of Finance, American Finance Association, vol. 48(1), pages 187-211, March.
  2. Harris, Lawrence, 1987. "Transaction Data Tests of the Mixture of Distributions Hypothesis," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(02), pages 127-141, June.
  3. O'Hara, Maureen & Oldfield, George S., 1986. "The Microeconomics of Market Making," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 21(04), pages 361-376, December.
  4. Lee, Charles M C & Ready, Mark J, 1991. " Inferring Trade Direction from Intraday Data," Journal of Finance, American Finance Association, vol. 46(2), pages 733-46, June.
  5. Glosten, Lawrence R, 1987. " Components of the Bid-Ask Spread and the Statistical Properties of Transaction Prices," Journal of Finance, American Finance Association, vol. 42(5), pages 1293-1307, December.
  6. Copeland, Thomas E & Galai, Dan, 1983. " Information Effects on the Bid-Ask Spread," Journal of Finance, American Finance Association, vol. 38(5), pages 1457-69, December.
  7. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  8. Thomas Ho & Hans Stoll, . "Optimal Dealer Pricing Under Transactions and Return Uncertainty," Rodney L. White Center for Financial Research Working Papers 27-79, Wharton School Rodney L. White Center for Financial Research.
  9. Anat R. Admati, Paul Pfleiderer, 1988. "A Theory of Intraday Patterns: Volume and Price Variability," Review of Financial Studies, Society for Financial Studies, vol. 1(1), pages 3-40.
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