Measuring the liquidity part of volume |
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| Institution: | 1. Université Paris-Dauphine, DRM Finance and CREST, France;2. Université de Cergy-Pontoise and THEMA (UMR 8184, CNRS), 33 Boulevard du Port, 95011 Cergy-Pontoise Cedex, France;1. Department of Economics, University of Haifa, Haifa 31905, Israel;2. Research Department, Federal Reserve Bank Boston, 600 Atlantic Avenue, Boston, MA 02210, USA;1. Schools of Economics: Interdisciplinary Center, Tel-Aviv University and CEPR, Israel;2. Zicklin School of Business, Baruch College, United States;1. University of Zurich, Department of Banking and Finance, Plattenstrasse 14, 8032 Zurich, Switzerland;2. University of Zurich, Department of Banking and Finance, Plattenstrasse 32, 8032 Zurich, Switzerland;3. ETH Zurich, Department of Mathematics, Rämistrasse 101, 8092 Zurich, Switzerland;1. Finance Discipline Group, UTS Business School, University of Technology, Sydney;2. San Jose State University, San Jose, CA, United States |
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| Abstract: | Based on the concept that the presence of liquidity frictions can increase the daily traded volume, we develop an extended version of the mixture of distribution hypothesis model (MDH) along the lines of Tauchen and Pitts (1983) to measure the liquidity portion of volume. Our approach relies on a structural definition of liquidity frictions arising from the theoretical framework of Grossman and Miller (1988), which explains how liquidity shocks affect the way in which information is incorporated into daily trading characteristics. In addition, we propose an econometric setup exploiting the volatility–volume relationship to filter the liquidity portion of volume and infer the presence of liquidity frictions using daily data. Finally, based on FTSE 100 stocks, we show that the extended MDH model proposed here outperforms that of Andersen (1996) and that the liquidity frictions are priced in the cross-section of stock returns. |
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| Keywords: | Volatility–volume relationship Mixture of distribution hypothesis Liquidity shocks Information-based trading Liquidity arbitrage GMM tests C51 C52 G12 |
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