Firm level governance and institutional determinants of liquidity: Evidence from Sub Saharan Africa

This study contrasts well established liquidity measures, namely volume-based turnover ratio, related price-impact Amihud (2002) construct and the multidimensional Liu (2006) indicator alongside the Lesmond, Ogden, and Trzcinka (1999) proportion of zero daily returns metric in explaining bid-ask spread plus commissions costs. We control for six critical firm governance characteristics that impact liquidity alongside the market-based controls that are conventionally solely included in the literature. Using a unique sample of 12 Sub Saharan African (SSA) equity markets, namely Kenya, Mauritius, Zambia, Zimbabwe, Botswana, Malawi, Namibia, Nigeria, Ghana, BRVM (Cote d'Ivoire), and then South Africa's ALT-x and Main boards we find evidence that state and foreign venture capitalist involvement in firms enhances liquidity while involvement of foreign partners, entrepreneurial founders, domestic venture capital and inclusion within an extended business or family network has opposite effect. The evidence supports the use of the proportion of daily zero returns measure in preference to other measures in capturing illiquidity. Furthermore we find that liquidity is closely associated with three of six World Bank Governance measures of institutional quality with these being government effectiveness, regulatory quality and rule of law.     

The relationship between bid–ask spreads and holding periods: The case of Chinese A and B shares

The Chinese stock markets for A (domestic) shares and B (foreign) shares were completely separated. This study examines the relationship between spreads and holding periods across these segmented markets on the same set of firms. Our major findings are as follows. (1) There is a positive relationship between holding periods and bid–ask spreads in the Chinese stock market. (2) Investors' sensitivity toward liquidity is approximately the same in the A and B share markets, even though bid–ask spreads are substantially different across the two markets. These results provide strong support for the theoretical argument of Amihud and Mendelson [Amihud, Y., & Mendelson, H. (1986). Asset pricing and the bid–ask spread. Journal of Financial Economics, 17, 223–249.] that stocks with higher spreads tend to be held by long-term investors. Evidence also suggests that liquidity has a role in explaining the B share discount, although the results are less than conclusive.     

The relationship between bid–ask spreads and holding periods: The case of Chinese A and B shares

The Chinese stock markets for A (domestic) shares and B (foreign) shares were completely separated. This study examines the relationship between spreads and holding periods across these segmented markets on the same set of firms. Our major findings are as follows. (1) There is a positive relationship between holding periods and bid–ask spreads in the Chinese stock market. (2) Investors' sensitivity toward liquidity is approximately the same in the A and B share markets, even though bid–ask spreads are substantially different across the two markets. These results provide strong support for the theoretical argument of Amihud and Mendelson [Amihud, Y., & Mendelson, H. (1986). Asset pricing and the bid–ask spread. Journal of Financial Economics, 17, 223–249.] that stocks with higher spreads tend to be held by long-term investors. Evidence also suggests that liquidity has a role in explaining the B share discount, although the results are less than conclusive.     

The relevance of information and trading costs in explaining momentum profits: Evidence from optioned and non-optioned stocks

Considerable evidence from many countries suggests momentum strategies generate profits. These have been difficult to rationalise and evidence on the sources of such profitability is inconclusive. We utilise a sample of optioned stocks, characterised by high liquidity, high market capitalisation and fewer short sales constraints and compare results with control samples of non optioned stocks chosen on the basis of market value, turnover and bid–ask spread. The sample characteristics, and the fact that derivatives improve the impounding of information into prices, enable us to draw conclusions about the causes of momentum profits. While we find that short sales constraints are not the major driver of profitability and that most momentum profits disappear using two transactions costs measures of the bid–ask spread, one not previously used, the persistence of some momentum profits indicates that the market underreacts even to the most publicly available information.     

Relative performance of bid–ask spread estimators: Futures market evidence

The issue of transaction costs is the mainstay of the equity market microstructure. Research in the microstructure of futures markets has lagged behind. A primary reason is that futures exchanges in the U.S. do not record bid–ask quotes, requiring these costs to be imputed from transaction price data. A reliable estimator of bid–ask spreads would significantly enhance microstructure research in futures markets. Unique intraday data from the Sydney Futures Exchange (SFE) that include both transaction prices and bid–ask spreads allow us to compare bid–ask spread estimation techniques proposed in the literature against the benchmark of actual spreads in a futures market, and thus identify the best-performing estimator. To maximize relevance, we impose all the constraints that apply in U.S. futures data to perform our estimations. We find that the four bid–ask spread estimators considered significantly underestimate the actual spreads. However, simple moments-based estimators perform better in predicting spreads.     

A Comparison of Centralized and Fragmented Markets with Costly Search

How does quotation transparency affect financial market performance? Biais's irrelevance proposition in 1993 shows that centralized markets yield the same expected bid–ask spreads as fragmented markets, other things equal. However, de Frutos and Manzano demonstrated in 2002 that expected spreads in fragmented markets are smaller and market participants prefer to trade in fragmented markets. This paper introduces liquidity traders' costs of searching for a better quote into the Biais model and derives opposite conclusions to these previous studies: expected spreads in centralized markets are smaller and liquidity traders prefer centralized markets, while market makers prefer fragmented markets.     

The impact of the French Tobin tax

We analyze the impact of the introduction of the French Tobin tax on the turnover and measures of the liquidity and volatility of the affected stocks with nonparametric tests on individual stocks, difference-in-difference tests and other robustness checks controlling for simultaneous month-of-the-year and size effects. Our findings indicate that the tax produces a significant reduction in turnover and volatility (measured in terms of stock price volatility and the high–low price range) and inconclusive effects on liquidity when the latter is evaluated under the two dimensions of the estimated bid–ask spread and the Amihud (2002) price impact ratio.     

Relation between bid–ask spread,impact and volatility in order-driven markets

We show that the cost of market orders and the profit of infinitesimal market-making or -taking strategies can be expressed in terms of directly observable quantities, namely the spread and the lag-dependent impact function. Imposing that any market taking or liquidity providing strategies is at best marginally profitable, we obtain a linear relation between the bid–ask spread and the instantaneous impact of market orders, in good agreement with our empirical observations on electronic markets. We then use this relation to justify a strong, and hitherto unnoticed, empirical correlation between the spread and the volatility per trade, with R ²s exceeding 0.9. This correlation suggests both that the main determinant of the bid–ask spread is adverse selection, and that most of the volatility comes from trade impact. We argue that the role of the time-horizon appearing in the definition of costs is crucial and that long-range correlations in the order flow, overlooked in previous studies, must be carefully factored in. We find that the spread is significantly larger on the NYSE, a liquid market with specialists, where monopoly rents appear to be present.     

Option market liquidity: Commonality and other characteristics

This study examines option market liquidity using Ivy DB's OptionMetrics data. We establish convincing evidence of commonality for various liquidity measures based on the bid–ask spread, volumes, and price impact. The commonality remains strong even after controlling for the underlying stock market's liquidity and other liquidity determinants such as volatility. Smaller firms and firms with a higher volatility exhibit stronger commonalities in option liquidity. Aside from commonality, we also uncover several other important properties of the option market's liquidity. First, information asymmetry plays a much more dominant role than inventory risk as a fundamental driving force of liquidity. Second, the market-wide option liquidity is closely linked to the underlying stock market's movements. Specifically, the options liquidity responds asymmetrically to upward and downward market movements, with calls reacting more in up markets and puts reacting more in down markets.     

On the premiums of iShares

We show that the newly developed exchange-traded world equity index funds, or iShares, trade at economically significant premiums for 10–50% of the times even after controlling for transaction costs and time-zone measurement errors. Moreover, iShares price returns exhibit excessive volatility relative to their NAV returns. These findings suggest a limit of arbitrage in the international iShares market where iShares can be created and redeemed at will and premiums that exceed the creation/redemption transaction costs should be immediately arbitraged away. However, our cointegration and persistence profile analyses indicate that the deviations of most iShares' prices from their NAVs are not persistent and converge to zero within two days. We propose several rational factors to explain the absolute value of iShares premiums. The panel regression results suggest that institutional ownership, bid–ask spread, trading volume, exchange rate volatility, political and financial crises and, to a lesser extent, the conditional correlation between the U.S. and home markets are the significant driving factors of the size of iShares premiums. However, a significant variation of the premiums still remains unexplained, which suggests that behavioral factors may account for some mispricing.     

Trading and liquidity in the catastrophe bond market

We provide first insights into secondary market trading, liquidity determinants, and the liquidity premium of catastrophe bonds. Based on transaction data from TRACE (Trade Reporting and Compliance Engine), we find that cat bonds are traded less frequently during the hurricane season and more often close to maturity. Trading activity indicates that the market is dominated by brokers without a proprietary inventory. Liquidity is high in periods of high trading activity in the overall market and for bonds with low default risk or close to maturity, which results from lower order processing costs. Finally, using realized bid–ask spreads as a liquidity measure, we find that on average, 21% of the observable yield spread on the cat bond market is attributable to the liquidity premium, with a magnitude of up to 141 bps for high-risk bonds.     

The Volatility of Bid‐Ask Spreads

This study tests whether the volatility of bid‐ask spreads is positively related to expected returns. After controlling for market‐risk factors, we find that the average risk‐adjusted excess return for stocks in the highest spread volatility quintile is around 50 basis points per month. In a variety of multivariate tests, we find robust evidence of a return premium associated with spread volatility that is both statistically significant and economically meaningful. Our results are robust to controls for a variety of stock characteristics, different tick‐size regimes, and other measures of liquidity volatility.     

Liquidity and Returns to Target Shareholders in the Market for Corporate Control: Evidence from the US Markets

In this paper we analyze how stock market liquidity affects the abnormal return to target firms in mergers and tender offers. We predict that target firms with poorer stock market liquidity receive larger announcement day abnormal returns based on the following considerations. First, target firms with poorer stock market liquidity receive greater liquidity improvements after a merger or tender offer. Second, deals that involve less liquid targets are less anticipated and/or more likely to be completed. Third, less liquid stocks have more diverse reservation prices across shareholders and thus require a higher takeover return. Consistent with these expectations, we show that abnormal returns to target firms’ shareholders are significantly and positively related to the difference in liquidity (measured by the bid‐ask spread) between acquirers and targets as well as the magnitude of target firms’ liquidity improvement.     

Do liquidity measures measure liquidity?

Given the key role of liquidity in finance research, identifying high quality proxies based on daily (as opposed to intraday) data would permit liquidity to be studied over relatively long timeframes and across many countries. Using new measures and widely employed measures in the literature, we run horseraces of annual and monthly estimates of each measure against liquidity benchmarks. Our benchmarks are effective spread, realized spread, and price impact based on both Trade and Quote (TAQ) and Rule 605 data. We find that the new effective/realized spread measures win the majority of horseraces, while the Amihud [2002. Illiquidity and stock returns: cross-section and time-series effects. Journal of Financial Markets 5, 31–56] measure does well measuring price impact.     

Intraday Patterns in the Cross‐section of Stock Returns

Motivated by the literature on investment flows and optimal trading, we examine intraday predictability in the cross‐section of stock returns. We find a striking pattern of return continuation at half‐hour intervals that are exact multiples of a trading day, and this effect lasts for at least 40 trading days. Volume, order imbalance, volatility, and bid‐ask spreads exhibit similar patterns, but do not explain the return patterns. We also show that short‐term return reversal is driven by temporary liquidity imbalances lasting less than an hour and bid‐ask bounce. Timing trades can reduce execution costs by the equivalent of the effective spread.     

Low-latency liquidity inefficiency strategies

The vast amount of high-frequency data heralds the use of new methods in financial data analysis and quantitative trading. This study delivers a proof-of-concept for a high frequency-based trading system based on an evolutionary computation method. Motivated by a theoretical liquidity asymmetry theorem from the market microstructure literature, grammatical evolution is used to exploit volume inefficiencies at the bid–ask spread. Using NASDAQ Historical TotalView-ITCH level two limit order book data, execution volumes can be tracked. This allows for testing of the strategies with minimal assumptions. The system evolves profitable and robust strategies with high returns and low risk.     

Short-term market reaction after extreme price changes of liquid stocks

In our empirical study we examine the dynamics of the price evolution of liquid stocks after experiencing a large intra-day price change, using data from the NYSE and the NASDAQ. We find a significant reversal for both intra-day price decreases and increases. Volatility, volume and, in the case of the NYSE, the bid–ask spread, which increase sharply at the event, stay significantly high days afterwards. The decay of the volatility follows a power law in accordance with the `Omori law'. While on the NYSE the large widening of the bid–ask spread eliminates most of the profits that can be achieved by an outside investor, on the NASDAQ the bid–ask spread stays almost constant, yielding significant short-term profits. The results thus give an insight into the size and speed of the realization of an excess return for providing liquidity in a turbulent market.     

The total cost of trading Belgian shares: Brussels versus London

Since 1990, London’s SEAQ International (SEAQ-I) has attracted considerable trading volume in Belgian equities. This paper investigates competition between the Brussels CATS market and London’s SEAQ-I. Toward this end, we gathered extensive limit order book data as well as transactions and quotation information. With regard to liquidity (indirect costs), measured by the quoted and effective bid–ask spread, the paper concludes that CATS outperforms SEAQ International for both measures. The effective spread is of course substantially smaller than the quoted spread, with the CATS effective spread showing a U-shaped form. This paper, unique in employing an extensive data set that includes all hidden orders and the whole limit order book, produces results in line with the different market microstructure models. Total trading costs on CATS are lower (higher) for small (large) trade sizes.     

A test of the accuracy of the Lee/Ready trade classification algorithm

We analyze the accuracy of the Lee/Ready (1991) trade classification algorithm and the tick test. Our definition of true trade classification is based on whether the Makler (the equivalent of the specialist on the Frankfurt Stock Exchange) bought or sold shares. The Lee/Ready method classifies 72.8% of the transactions correctly. The simpler tick test performs almost equally well. We document that misclassification of trades may systematically bias the results of empirical microstructure research. Finally, we show that estimation of the bid–ask spread from transaction data results in a reasonably accurate estimate of the relative liquidity of our sample stocks. This is an important finding because quote data for the German stock market is not available on a regular basis.     

Measuring the liquidity impact on EMU government bond prices

Abstract

The work reported in this paper aimed to measure the impact of liquidity on European Monetary Union (EMU) government bond prices. Although there is a growing theoretical and empirical literature on liquidity effects in fixed income markets there is no clear answer to the questions how to measure liquidity and whether liquidity is priced in the market at all. The empirical analysis here is based on a unique data set containing individual bond data from six major EMU government bond markets, allowing one to compare yield curves estimated for subportfolios formed with respect to different potential liquidity measures. In a second procedure, liquidity measures are collected on the individual bond level and estimated pricing errors, given some reference yield curve, are regressed against these liquidity variables. This enables the conduction of formal tests on the pricing impact of liquidity measures. Results indicate that the benchmark property and the number of contributors are the most promising liquidity proxies having significant results in most countries. The results do not support the hypothesis that other liquidity measures under consideration, such as the on-the-run property, the issue size, and bid–ask spread related measures have a persistent price impact. A cross-country analysis of the subportfolio level indicates that liquidity effects cannot explain the size of the yield spreads between different issuers. This implies that effects other than liquidity, such as credit risk, are important driving factors of cross-country yield spreads.