Abstract
During times of market stress, arbitrage capital cannot be timely deployed, and assets trade away from fundamentals. This gives rise to transitory price volatility, a latent factor that signals difficulties in the market-making process. I propose a market-wide illiquidity measure based on SPY's transitory volatility (SPY is an ETF that tracks the S&P500). While related to existing illiquidity proxies, the proposed measure provides additional information. It also captures commonality in stock-level illiquidity, and it is priced in the stock market. An investment strategy based on it earns, on average, an 8.76% annual premium, which cannot be explained by classical risk factors, including existing illiquidity measures. Finally, I extend the methodology to the Treasury market, where I propose a funding illiquidity proxy, and I examine the cross-market liquidity dynamics.
Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a call
