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Estimating endogenous liquidity using transaction and order book information

  • Durand, Philippe
  • Gündüz, Yalin
  • Thomazeau, Isabelle

We distinguish exogenous liquidity, which corresponds to the variability of bid-ask spreads for usual-sized transactions, from endogenous liquidity, which we interpret as the impact of liquidity on market prices when liquidating larger positions. Endogenous liquidity measures the risk that the realized price of a transaction may be different from the price before the transaction. We apply an endogenous liquidity-based model to order books and credit default swap (CDS) transactions in order to understand two different phenomena. An order book of equity prices has been utilized so as to reveal any 'not yet realized' endogenous liquidity effects, i.e. any effects that become real if a new order is executed. Our results indicate that measuring the impact of the endogenous liquidity on the valuation of the portfolio is quite realistic. Second, we apply our model to a set of CDS transactions in order to find a 'realized' endogenous liquidity component. We conclude that a realized systemic component is not present in realized CDS transactions, probably due to placing of iceberg orders, simply by slicing the large transactions into several small pieces to avoid liquidity constraints: Traders know perfectly where endogenous liquidity starts when they execute their transactions.

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Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Papers with number 34/2012.

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Date of creation: 2012
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Handle: RePEc:zbw:bubdps:342012
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