A Multi-Factor Measure for Cross-Market Liquidity Commonality

Abstract

Liquidity commonality is defined as liquidity co-movements across assets or markets. In the current literature, it is measured relative to a single factor, i.e., the average liquidity across assets or markets. However liquidity co-movements may not be fully captured by this single factor. Other factors, e.g., aggregate return and volatility, may also contribute to liquidity comovements. Using Asian stock markets as an example, this paper reports that following findings: (1) From January 2000 to April 2010, cross-market liquidity commonality accounts over 9% of daily liquidity variations for Asian emerging markets, and around 14% for Asian developed markets. These numbers are considerably higher than the 1% to 2% reported in previous studies based on cross-asset liquidity commonality. (2) Regional factors affect liquidity commonality through shocks in liquidity and volatility, while global factors affect liquidity commonality through return and volatility. (3) Cross-market liquidity commonality has increased significantly during and after the recent global financial crisis, accounting up to 14% and 21% of liquidity variations in Asian emerging and developed market respectively. It is not very sensitive to bull-bear market cycles. The large and rising common liquidity component across regional markets has significant implications for international portfolio flows and risk management.