Noise as Information for Illiquidity
We propose a market-wide liquidity measure by exploiting the connection between the amount of arbitrage capital in the market and observed “noise” in U.S. Treasury bonds—the shortage of arbitrage capital allows yields to deviate more freely from the curve, resulting in more noise in prices. Our nois...
| Main Authors: | , , |
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| Other Authors: | |
| Format: | Article |
| Language: | en_US |
| Published: |
John Wiley & Sons, Inc
2014
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| Online Access: | http://hdl.handle.net/1721.1/88025 https://orcid.org/0000-0003-0161-9465 https://orcid.org/0000-0002-8261-0261 |
| Summary: | We propose a market-wide liquidity measure by exploiting the connection between the amount of arbitrage capital in the market and observed “noise” in U.S. Treasury bonds—the shortage of arbitrage capital allows yields to deviate more freely from the curve, resulting in more noise in prices. Our noise measure captures episodes of liquidity crises of different origins across the financial market, providing information beyond existing liquidity proxies. Moreover, as a priced risk factor, it helps to explain cross-sectional returns on hedge funds and currency carry trades, both known to be sensitive to the general liquidity conditions of the market. |
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