Price Discovery And Liquidity In A Fragmented Stock Market

Ye, Mao. 2011. Price Discovery And Liquidity In A Fragmented Stock Market. Doctoral Dissertation, Cornell University.

One of the most striking changes in U.S. equity markets has been the proliferation of trading venues. My dissertation studies the impact of market fragmentation on liquidity and price discovery from three different perspectives. The first section, coauthored with Maureen O'Hara, examines how fragmentation of trading is affecting the quality of trading. We use newly-available trade reporting facilities volumes to measure fragmentation levels in individual stocks, and we use a matched sample to compare execution quality and efficiency of stocks with more and less fragmented trading. We find market fragmentation generally reduces transaction costs, as measured by effective spread and realized spread, and increases execution speeds. Fragmentation does increase short-term volatility, but prices are more efficient in that they are closer to being a random walk. The second section focuses on a particular type of new trading mechanism, crossing network, in which buy and sell orders are passively matched using the price set by the stock exchange. The results show that the crossing network harms price discovery and the relative lack of revealed information most strongly affects stocks with high uncertainty in their fundamental values. I find that an increase in the uncertainty of the fundamental value of the asset increases the transaction costs in both markets, but stocks with higher fundamental value uncertainty are more likely to have higher market shares in the crossing network. The impact of different allocation rules in the crossing network on market outcomes is also examined. The third section tests the theoretical prediction of the second essay. I find that crossing networks have lower effective spread and price impact of trade, but they also have lower execution probability and speed of trade. Non-execution is positive correlated with price impact, decreases in trading volume and increases in volatility. Crossing networks have higher market share for stocks with lower volatility and higher volume. We also find that the underlying assumption in previous literature, that stocks with higher effective spreads have higher reductions in effective spread by trading in crossing networks, is not supported by data.

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Institutional Ownership, Liquidity and Liquidity Risk

Agarwal, Prasun. 2009. Institutional Ownership, Liquidity and Liquidity Risk. Doctoral Dissertation, Cornell University.

In this dissertation, I focus on examining the effects of institutional ownership on stocks' liquidity and liquidity risk using a sample of firms listed on the NYSE and the AMEX over the period 1980-2005. The first chapter provides a brief introduction to liquidity and emphasizes the role of institutional ownership in financial markets. In the second chapter, I examine the relationship between institutional ownership and liquidity of stocks, focusing on the effect of institutions' relative information advantage. The information advantage of institutions can affect liquidity through two channels: decreasing liquidity resulting from increasing information asymmetry (adverse selection effect) and increasing liquidity resulting from increasing price discovery due to competition among institutions' information efficiency effect.

My evidence indicates a non-monotonic (U-shaped) relationship between the level of institutional ownership and stock liquidity. The two effects vary with the amount of publicly available information and asset risk. I also find that institutional ownership (Granger) causes liquidity, allaying concerns that the findings result from institutions' preference for liquid stocks. Lastly, I document that liquidity decreases with increasing diversification of the portfolio of institutional investors and the fraction of equity held by long-term investors.

In the third chapter, I examine the effects of institutional ownership on stocks' time variation in liquidity. It helps advance an understanding of the sources of commonality in liquidity and the determinants of the sensitivity of an asset's liquidity to changes in market-wide liquidity (systematic liquidity risk) and the total variance of liquidity of a firm over time. I interpret my findings in the context of correlated trading by institutions resulting either from their tendency to herd or to trade on common information and signals. I find that systematic liquidity risk increases with the level of institutional ownership, homogeneity and investment-horizon of the institutional investor base, while it decreases with ownership concentration and increase in blockholdings. However, the variance of liquidity decreases with the level of institutional ownership, homogeneity of the investor base and ownership concentration. Overall, the findings indicate that the ownership structure of stocks affects both the systematic liquidity risk and the variation in their liquidity over time.

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Essays On Asset Pricing: Predictability, Information, And Liquidity

Chen, Qingqing. 2009. Essays On Asset Pricing: Predictability, Information, And Liquidity. Doctoral Dissertation, Cornell University.

This dissertation is a collection of essays on Asset Pricing: Predictability, Information, and Liquidity. The first chapter, Predictability of Equity Returns over Different Time Horizons: A Non-parametric Approach? aims to test an important hypothesis in financial economics: whether equity returns are predictable over various horizons? We first propose a non-parametric test to examine the predictability of equity returns, which can be interpreted as a signal-to-noise ratio test. Our empirical results show that the short rate, dividend yields and earnings yields have good predictability power for both short and long horizons, which is different from both the conventional wisdom and Ang and Bekaert (2007). Also, using our non-parametric test, a comprehensive in-sample and out-of-sample analysis documents that the predictor variables (dividend yields, earnings yields, dividend payout ratio, short rate, inflation, book-to-market ratio, investment to capital ratio, corporate issuing activity, and consumption, wealth, and income ratio) have predictability power on equity returns but this cannot be well captured by linear prediction models. In addition, we use the nonparametric test to compare the conventional long-horizon prediction regression models on predictor variables with the historical mean model, where there has exists a debate about which model has better forecasting power for equity returns (Campbell and Thompson (2007) and Goyal and Welch (2007)). We find that the prevailing prediction model has a better forecasting power than the historical mean model because the former has a lower neglected signal-to-noise ratio. Finally, we find that our nonparametric predictive models have lower RMSE than the historical mean model at both short-horizon and long-horizon. Using our non-parametric methods, both combined and individual forecast outperform the historical average. The second chapter, An Intraday Analysis of Related Investment Vehicles Traded in the NYSE and AMEX? undertakes an intraday analysis of related, investment vehicles traded in the NYSE and AMEX. I investigate how the trading behaviors of three related investment vehicles (American Depository Receipt, Exchange-traded Fund, and Closed-end Fund) differ across countries using high-frequency intraday data. I ?nd that ADRs trade at transaction prices that are on average worse than ETFs and CEFs. The trading of ADRs, ETFs, and CEFs follows positive feedback strategies. The buy and sell trades of the three securities are driven by the net order imbalances and past returns of three securities themselves. The correlated trading behaviors of the three securities can be explained by momentum traders with a common information set. The third chapter, “Endogenous Information Acquisition, Cost of Capital, and Comovement of Equity Returns” investigates endogenous information acquisition, , cost of capital, and comovement of equity returns. The traditional asset pricing model cannot provide a good explanation for the comovement of asset returns. This chapter introduces endogenous costly information acquisition that generates comovement of asset returns in a rational expectations framework. The private information signals observed by many investors contain information not only about the value of the asset itself, but also the value of many other assets. This common source of information causes excessive covariance in their returns. If informed investors acquire more private information, or more investors are informed, the comovement of asset returns will increase. On the other hand, if informed investors aggressively obtain abundant private information, the comovement will decrease. We also find that both greater precision in private information and higher cost of information will increase a company cost of capital’s.

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Essays On Risk Biased Exports And Liquidity-Based Determinants Of International Equity Flows

Serechetapongse, Anuk. 2013. Essays On Risk Biased Exports And Liquidity-Based Determinants Of International Equity Flows. Doctoral Dissertation, Cornell University.

This dissertation is comprised of three essays. Chapter One develops a general equilibrium framework to address risk-shifting factors in a country allocation of resources between the domestic and export sector. The analytical framework introduces credit frictions as in Allen and Gale (2000) to the general equilibrium model of Helpman and Razin (1978), which features the allocation of factors of production across two sectors of an open economy under uncertainty. The risk bias hinges on the imperfect ability of lenders to monitor the usage of the borrowed funds. Borrowers would invest more on the equities of the risky production sector. This is because if the returns of those equities are high, they would repay the promised return and keep the remaining profits from their investment. However, if the returns are low, they can just default and avoid further losses. Such risk-shifting behavior, which tends to make the risky (export) sector equities overpriced, will lead to also to overinvestment in this sector, and excessive allocation of labor to it. As a result, the production and export pattern to be geared towards the risky sector, which may expose a country to increased macroeconomic volatility. Chapter Two provides an empirical test to key predictions of the theory, which is developed in Chapter One. Specifically, it uses cross-country panel data to test whether low degree of monitoring borrowers by financial intermediaries would contribute to a shift in a country's exports towards risky production sectors. It analyzed the data measuring the riskiness across sectors, developed by Koren and Tenreyro (2007) and Di Giovanni and Levchenko (2011), from developed and developing economies over the period of 1978-2004. The explanatory variable of interest is the creditor rights index (CRI) because it captures the degree of enforcing debt repayment and thus reflects the lenders' ability to observe the borrowers' actions. The dependent variable is the risk content of exports index, which is constructed by multiplying the square of each sector's share of exports to the variance of the sectoral value added growth. The higher value of the index indicates that a country has higher shares of exports in the sectors whose productions are more volatile. Using fixed effects regressions, the results revealed that countries where lenders have lower ability to monitor borrowers are the ones with higher risk content of exports. This finding remained robust even after excluding the most volatile production sectors from the analysis. And when separately examining the effects of the four different components of creditor rights index, it is shown that the effects of creditor rights arises from the restrictions on the borrowers' filing for reorganization. Chapter Three, addressing international equity flows, provides empirical tests to three theory-based hypotheses concerning foreign equity investment in the presence of liquidity risk. First, the FDI-to-FPI price differential is negatively related to liquidity risk (the "Price Discount Hypothesis"). The idea is that direct investments would incur a price discount because market participants do not know whether the FDI investor liquidates a firm because of an idiosyncratic liquidity shock, or because, as an informed investor, the firm is hit by a productivity shock. Second, the FDI-to-FPI composition would skew towards FPI if investors expect to experience liquidity shortage in the future (the ""Equity-Composition Hypothesis"). Since direct investments are more costly to liquidate, due to the price discount, investors would be inclined to hold less FDI if they expect more severe liquidity shock. The third hypothesis, on the other hand, states that the FDI-to-FPI composition would skew towards FDI if the past FDI-to-FPI stocks were larger (the "Strategic Complementarity Hypothesis"). If the initial proportion of direct investments is higher, it is more likely that a direct investment is sold due to liquidity needs. This improves the price of the prematurely sold direct investment, creating an incentive for more investors to choose FDI rather than FPI. These hypotheses are examined using the country level data consisting of a large set of developed and developing countries over the period 1970 to 2004. The nationwide sales of external assets are used as a proxy for liquidity problems, and the effect of expected liquidity problems on stock prices, the ratio of FPI to FDI and gross flows of FDI and FPI are tested. The empirical results support the three hypotheses.

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Liquidity Risk, Volatility and Financial Bubbles

Roch, Alexandre. 2009. Liquidity Risk, Volatility and Financial Bubbles. Doctoral Dissertation, Cornell University.

The goal of this work is to study and characterize the hedging and pricing of contingent claims and develop a theory of financial bubble origination and termination from a liquidity risk and trading impacts perspective. Our approach is to combine both notions of liquidity risk by hypothesizing the existence of a linear supply curve that evolves randomly in time and by studying the impact of trades on prices. This leads to a simple characterization of self-financing trading strategies in which the profit is directly affected by the level of liquidity. The main goal of Chapter 3 is to study the effect of liquidity risk on the replicating costs of contingent claims. The use of variance swaps will prove to be helpful and mathematically tractable in this context. In Chapter 4, we show that the replicating cost obtained can be represented as the viscosity solution of an associated quasi-linear partial differential equation. In Chapter 5, we build on the work of Chapter 3 and study the case of American options. We obtain a general result concerning reflected forward-backward stochastic differential equations, and apply these results to the problem of hedging American options. In Chapter 6, we study the relation between bubbles and liquidity risk. In particular, we use the model presented in Chapter 3 to analyze the formation and the bursting of financial bubbles from a price impact and liquidity risk perspective. The approach differs from the existing theory of bubble birth as it consists in fixing a fundamental process, thereby fixing the equivalent martingale measure used for valuation, and considering conditions under which the mar- ket price gives rise to a bubble. We show how the life of a bubble is determined by quantities such as the trading volume, the resiliency of the order book, the level of liquidity and the speed of price impact decay. We give sufficient conditions for the no arbitrage condition to hold at the time of bubble creation. In the last part of the chapter, we study the implication of positive probability of future bubbles on option prices and show that information about the likelihood of this future event is contained in option prices before the event happens. In Chapter 7, we use the notion of viscosity solutions of integral-partial differential equations (IPDE) studied in previous chapters for the pricing of American options in the stochastic volatility model of Barndorff-Nielsen and Shephard (2001).

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Essays On International Investment Allocation: The Role Of Liquidity, Asymmetric Information And Beliefs

Kirabaeva, Koralai. 2009. Essays On International Investment Allocation: The Role Of Liquidity, Asymmetric Information And Beliefs. Doctoral Dissertation, Cornell University.

My dissertation addresses topics of international finance. The first chapter develops a theoretical framework to analyze the composition of foreign investment during liquidity crises. The second chapter examines the role of adverse selection and liquidity in the breakdown if trade during crisis. The third chapter studies the equity home bias puzzle in a decision-theoretic framework. In the first chapter, I develop a two-country model that analyzes the composition of capital flows (direct vs. portfolio) across two countries in the presence of heterogeneity in liquidity risk and asymmetric information about investment productivity. Direct investment is characterized by higher profitability and private information about investment productivity, while portfolio investment provides greater risk diversification. I demonstrate the possibility of multiple equilibria due to strategic complementarities in choosing direct investment. I analyze the effect of an increase in the liquidity risk on the composition of foreign investment. If there is a unique equilibrium, then higher liquidity risk leads to a higher level of foreign direct investment (FDI). If, however, there are multiple equilibria, higher liquidity risk may lead to the opposite effect, a decline of FDI. In this case, an outflow of FDI is induced by self-fulfilling expectations. The dual effect of increased liquidity risk on capital flows can be related to empirically observed patterns of foreign investment during liquidity crises. Furthermore, my model offers a liquidity-based explanation for the phenomenon of bilateral FDI flows among developed countries, and one-way FDI flows from developed to developing countries. In the second chapter, I present a model that illustrates how adverse selection in financial markets can lead to increased asset price volatility and possibly to a breakdown of trade. The asymmetric information about asset returns generates the Akerlof's lemons problem, where buyers do not know whether the asset is sold because of its low quality or because the seller has experienced a sudden need for liquidity. The adverse selection can lead to equilibrium with no trade, reflecting the buyers' belief that most assets that are offered for sale are of low quality. I analyze the role of market liquidity and beliefs about likelihood of a crisis in amplifying the effect of adverse selection. In the third chapter, I apply the smooth model of decision making under ambiguity to study the equity home bias puzzle. I show that difference in beliefs about perceived uncertainty, characterized by optimism or overconfidence, can significantly contribute to the explanation of the equity home bias observed in the data. I examine how ambiguity about the distribution of asset returns affects equilibrium prices and equity holdings in a two-country CARA-normal setting. All investors possess the same information about the set of possible states and the corresponding returns distribution in each state, but they have different beliefs about the likelihood of these states. In this setting, optimism and overconfidence refer to distorted beliefs about the expected mean and the dispersion of the asset returns distribution, respectively. I analyze and quantify the effects of optimism and overconfidence on asset prices and asset holdings when investors are ambiguity averse. Furthermore, I show that the equity home bias is larger in countries with smaller market capitalization.

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Liquidity and Commonality in Emerging Markets

Yafeng, Qin. 2007. Liquidity and Commonality in Emerging Markets. Doctoral Dissertation, NUS.

This study investigates the extent to which liquidity of emerging market stocks co-moves with each other, and tries to explore the underlying mechanism that drives commonality in liquidity. The empirical results show that in emerging markets, commonality in liquidity is significantly higher than that in developed markets, and individual stock liquidity is more affected by fluctuations in market prices than by fluctuations in individual stock prices, suggesting that higher commonality in liquidity in emerging markets could be caused by higher co-variation in stock volatility and inventory risk. Consistent with this conjecture, commonality in liquidity is found to be positively related to co-movement in volatility. These findings reinforce the idea that liquidity commonality is related to market-wide factor. The study also documents that liquidity co-movement across emerging markets has a strong geographic component. The initial results do not support the presence of a global liquidity factor.

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Measuring Liquidity in Emerging Markets

Huiping, Zhang. 2011. Measuring Liquidity in Emerging Markets. Doctoral Dissertation, NUS.

This study propose a new liquidity measure, Illiq_Zero, which incorporates both the trading frequency and the price impact dimensions of liquidity. Based on the transaction-level data for 20 emerging markets from 1996 to 2007, Huiping conduct a comparison analysis on the new liquidity measure and the other existing liquidity proxies. The results indicate that the new liquidity measure shows the highest correlations with the liquidity benchmarks. The Amihud illiquidity ratio of absolute stock returns to trading volume and the Zeros measure defined as the proportion of zero return days within a month are moderately correlated with the liquidity benchmarks and their performance is related to the trading activeness of the market.

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Analisis Korelasi Antara Faktor-Faktor Fundamental Dengan Beta

Sumber :	Akuntabilitas :  Jurnal Ilmiah Akuntansi
Penerbit :	Jurusan Akuntansi Universitas Pancasila
Tahun Terbit Artikel:	2008
Volume :	7
No :	2
Halaman :	114-121
Kata Kunci :	Liquidity (economics); Leveraged buyouts; Assets
Sari :
Abstrak :	This research is aimed at investigating the correlation between the fundamental factors (liquidity, leverage and assets growth) with beta as the firm risk measurement (Fowler and Rorke, 1970), especially in the manufacturing company. The sample for this research is 15 textiles manufacturing companies listed in Indonesian Stock Exchange from 2002 -2006 as the sample for this research. Data were collected by means of purposive sampling, and the analytical methods used are those of multiple regression. The result of the regression analysis for the correlation between independent variable (liquidity, leverage and assets growth) and the dependent variable, shows that leverage and assets growth significanly influences as the alfa 5% or 0,05. Where as the liquidity do not significantly influence as the alfa 5%.
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Rasio Likuiditas dan Risiko Sistematik Pasar Saham LQ45 di Bursa Efek Indonesia

Sumber :	Akuntabilitas : Jurnal Ilmiah Akuntansi
Penerbit :	Jurusan Akuntansi Universitas Pancasila
Tahun Terbit Artikel:	2007
Volume :	7
No :	1
Halaman :	85-95
Kata Kunci :	Liquidity (economics); Stock market; Indonesia
Abstrak :	Many researchs show that there is a relationship between financial ratios and market risk, both partially and simultantly. Basically, this risk can be divided in two aspects. There are systematic risk and non-systematic risk. Liquidity ratio is one of those financial ratios. This research is to show the relationship between the liquidity ratio and the systematic market risk. By using LQ45 stocks, for the period of August 2006 to January 2007, it is concluded that there is positive relationship between liquidity ratio and systematic market risk for the year of 2003 and 2004, but there is no relationship between both variables in 2004. Furthermore, this ratio is not enough to elaborate the market risk. It is sugested that in order to clarify the systematic market risk, all financial ratios is better used comprehensively to show the risk.
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