Liquidity: Empirical Perspectives
Saturday, Jan. 6, 2018 10:15 AM - 12:15 PM
- Chair: Nicolae Gârleanu, University of California-Berkeley
Funding Liquidity Risk and the Cross-section of MBS Returns
AbstractThis paper shows that funding liquidity risk is priced in the cross-section of excess
returns on agency mortgage-backed securities (MBS). We derive a measure of funding
liquidity risk from dollar-roll implied financing rates (IFRs), which reflect security-level
costs of financing MBS positions. We show that factors representing higher net MBS
supply are associated with higher funding costs. We also find that funding liquidity
risk is compensated in the cross-section of expected returns—securities that are better
hedges against market-wide funding liquidity shocks on average deliver lower excess
returns—and that this premium is separate from compensation for prepayment risk.
Funding Liquidity Shocks in a Quasi-Experiment: Evidence from the CDS Big Bang
AbstractA major regulatory event in April 2009, the so-called “CDS Big Bang,” induces upfront fees for trading CDSs. This funding shock, combined with several other shocks that took place soon afterwards (the CDS Small Bang, central clearing, and Deutsche Bank’s exit from the CDS market) offers a rich setup to not only quantify the negative market liquidity effect from funding shocks, but also examine the economic mechanism behind this effect. This funding shock also increases the absolute value of the CDS-bond basis, and the effect is stronger if arbitrageurs are the payers, rather than the receivers, of the upfront fees.
Dimensional Analysis, Leverage Neutrality, and Market Microstructure Invariance
AbstractThis paper combines dimensional analysis, leverage neutrality, and a principle of market microstructure invariance to derive scaling laws expressing transaction costs functions, bid-ask spreads, bet sizes, number of bets, and other financial variables in terms of dollar trading volume and volatility. The scaling laws are illustrated using data on bid-ask spreads and number of trades for Russian and U.S. stocks. These scaling laws provide practical metrics for risk managers and traders; scientific benchmarks for evaluating controversial issues related to high frequency trading, market crashes, and liquidity measurement; and guidelines for designing policies in the aftermath of financial crisis.
- G1 - General Financial Markets