Liquidity derivatives

  • It is well established that investors price market liquidity risk. Yet, there exists no financial claim contingent on liquidity. We propose a contract to hedge uncertainty over future transaction costs, detailing potential buyers and sellers. Introducing liquidity derivatives in Brunnermeier and Pedersen (2009) improves financial stability by mitigating liquidity spirals. We simulate liquidity option prices for a panel of NYSE stocks spanning 2000 to 2020 by fitting a stochastic process to their bid-ask spreads. These contracts reduce the exposure to liquidity factors. Their prices provide a novel illiquidity measure refllecting cross-sectional commonalities. Finally, stock returns significantly spread along simulated prices.

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Author:Matteo BagnaraORCiD, Ruggero Jappelli
Parent Title (English):SAFE working paper ; No. 358
Series (Serial Number):SAFE working paper (358)
Place of publication:Frankfurt am Main
Document Type:Working Paper
Year of Completion:2022
Year of first Publication:2022
Publishing Institution:Universit├Ątsbibliothek Johann Christian Senckenberg
Release Date:2022/09/15
Tag:Asset Pricing; Liquidity Risk; Market Liquidity
Issue:September 2022
Page Number:55
We gratefully acknowledge research support from the Leibniz
Institute for Financial Research SAFE.
Institutes:Wirtschaftswissenschaften / Wirtschaftswissenschaften
Wissenschaftliche Zentren und koordinierte Programme / House of Finance (HoF)
Wissenschaftliche Zentren und koordinierte Programme / Center for Financial Studies (CFS)
Wissenschaftliche Zentren und koordinierte Programme / Sustainable Architecture for Finance in Europe (SAFE)
Dewey Decimal Classification:3 Sozialwissenschaften / 33 Wirtschaft / 330 Wirtschaft
JEL-Classification:G Financial Economics / G1 General Financial Markets / G12 Asset Pricing; Trading volume; Bond Interest Rates
G Financial Economics / G1 General Financial Markets / G13 Contingent Pricing; Futures Pricing
G Financial Economics / G1 General Financial Markets / G17 Financial Forecasting (Updated!)
Licence (German):License LogoDeutsches Urheberrecht