Liquidity commonality beyond best prices: Indian evidence

Abstract

This paper investigates the phenomenon of liquidity commonality in the Indian market, for the 3-year period spanning 2015–2017. Principal component analysis and canonical correlation analysis are performed on a number of liquidity proxies to provide the evidence of commonality. Following the market model of Chordia et al. (J Financ Econ 56(1):3–28, 2000), we show that the level of liquidity commonality for this order-driven emerging market is higher, as compared to that reported for quote-driven markets. There is evidence to suggest that both the inventory and information asymmetry hypotheses significantly contribute to the commonality in this important emerging market. Commonality is observed even at the deeper levels beyond the best prices, indicating a significant role of information asymmetry hypothesis. The study also provides evidence of specific intraday patterns in liquidity and ‘free-entry and free-exit’ phenomenon.