Improve Market Liquidity Research Articles

An analysis of impact of cancellation activity on market quality: Evidence from China

This study investigates whether cancellation activity is beneficial to Chinese stock market trading quality. Using high-frequency data on the five best bid–ask quotes and tick-by-tick executions, we propose a new cancellation measure based on limit order flow without relying on direct cancellation data. We find that market quality has a significant positive association with cancellation activity. Specifically, an increased level of order cancellation improves market liquidity by decreasing the effective spread, quote volume imbalances, order dispersion, and trading costs. Moreover, we show that cancellation activity causes increased market trading activity with more aggressive orders and a higher trading frequency. Our results strongly support that cancellation activity improves the Chinese stock market quality.

The impact of trading behavioral biases on market liquidity under different volatility levels: Evidence from the Chinese commodity futures market

AbstractThis paper investigates a sample of 15 Chinese commodity futures to examine the impact of trading behavioral biases on market liquidity under different volatility levels. We construct a measure of shocks driven by news on market fundamentals to capture rational trading behavior and a measure of irrational trading behavior from excess skewness, excess kurtosis, and excess turnover. We find that herding causes deterioration in liquidity mainly by affecting order imbalance, whereas overtrading improves market liquidity by increasing market depth. The disposition effect is identified only when volatility is higher, after a distinction is made between up and down markets.

Capital market and economic growth in Malaysia: the role of ṣukūk and other sub-components

Purpose The purpose of this paper is to explore the effects of the capital market on economic growth by considering the role of ṣukūk (Islamic investment certificates) and other capital market sub-components in Malaysia between 1998 and 2018. Design/methodology/approach The empirical investigation is based on the autoregressive distributed lag (ARDL) cointegration bounds test. Findings The results reveal the prevalence of a long-run equilibrium relationship between capital market variables and economic growth. As expected, bond market components (ṣukūk and conventional bonds) have a positive, albeit insignificant influence on economic growth. In contrast, in the long-term, stock market development – regardless of the indicator used on economic growth – is shown to have a significant and positive effect. The study suggests that stock market sub-components affect Malaysia’s economic growth the most. Research limitations/implications The primary limitation of this study is that only corporate ṣukūk were considered, while government ṣukūk were excluded from the estimation due to a lack of requisite information, resources and data. Practical implications A strategic framework should be established, especially in pricing efficiencies. Furthermore, there is a need to create more awareness on the benefits of ṣukūk investment among conventional bond investors, including retail investors. Thus, there will be more players in the ṣukūk market, and this will help to improve market liquidity. Originality/value Apart from conventional capital market sub-components, this study takes into account ṣukūk as a sub-component in the capital market on economic growth using the ARDL framework. Also, this study particularly concentrates on the world’s largest ṣukūk issuer, Malaysia, rather than focusing on other ṣukūk-issuing countries.

High-Yield Bond Markets During the COVID-19 Crisis: The Role of Monetary Policy

This article documents the difference in corporate bond issuance between the euro area (EA) and the United States (US) in 2020, especially in the high-yield (HY) segment, and discusses the role that the monetary policy measures undertaken by the US Federal Reserve (Fed) and the ECB in response to the Covid-19 crisis may have played in explaining such difference. We document that the issuance of HY bonds since February 2020 has been lower by historical standards in the EA than in the US. The Fed’s measures aimed at the HY segment, mainly the purchase of HY bond exchange traded funds (ETFs), could have reduced credit spreads and improved market liquidity, which in turn could have stimulated debt issuance. Alternatively, HY issuers in the EA may have faced better bank funding conditions due to the ECB’s targeted longer term refinancing operations (TLTRO) and to other measures by national fiscal authorities, leading such issuers to substitute bank credit for bond finance. The article discusses these possibilities and argues that they all may have played a role to a certain extent.

MiFID II: The Impact of Double Volume Cap Mechanism on Market Quality

I provide a comprehensive evaluation of the Double Volume Cap mechanism, a regulation that regularly triggers dark trading suspension based on a stock's historical dark trading activity. By analysing the impact of each suspension wave occurring between 2018 and 2020, I show that, during the pre-COVID-19 pandemic period, the dark trading suspension improves market liquidity, worsens informational efficiency, and reduces return volatility, whereas, during the post-COVID-19 pandemic period, the suspension imposes exactly opposite effects on market quality. I also find that lifting the dark trading suspension induces exactly opposite impacts, with a larger effect size, compared to triggering suspension, providing more statistically powerful evidence of how dark trading affects market quality. These results imply that the Double Volume Cap mechanism may have brought about many unintended consequences to the market when the market needs liquidity and stability the most and when the suspension is relaxed. Nevertheless, I do identify evidence that the market gradually learns and adapts to the new trading environment as market participants reduce their reliance on dark pools over time, a result consistent with the policymaker's original objective.

Do Intra-day Auctions Improve Market Liquidity?

The intra-day auction launched by the London Stock Exchange (LSE) on 21 March 2016 was designed as a mechanism to boost midday liquidity. During the auction time, Multilateral Trading Facilities (MTFs) as competitors of the LSE, continue their normal trading. We examine the midday liquidity changes on both the LSE and MTFs and analyze their implications on platform competition. The intra-day auction in general improves liquidity at midday on both the LSE and MTFs. The intra-day auction helps consolidate the primary status of the LSE by increasing its market share at midday. Liquidity on MTFs drops considerably during the auction and bounces back toward the normal level when the auction ends. Overall, the midday liquidity patterns indicate the LSE's competitive advantages over MTFs in providing market liquidity after the launch of the intra-day auction.

Do intra-day auctions improve market liquidity?

The intra-day auction launched by the London Stock Exchange (LSE) on 21 March 2016 was designed as a mechanism to boost midday liquidity. During the auction time, Multilateral Trading Facilities (MTFs) as competitors of the LSE, continue their normal trading. We examine the midday liquidity changes on both the LSE and MTFs and analyze their implications on platform competition. The intra-day auction in general improves liquidity at midday on both the LSE and MTFs. The intra-day auction helps consolidate the primary status of the LSE by increasing its market share at midday. Liquidity on MTFs drops considerably during the auction and bounces back toward the normal level when the auction ends. Overall, the midday liquidity patterns indicate the LSE's competitive advantages over MTFs in providing market liquidity after the launch of the intra-day auction.

(When) Does Transparency Hurt Liquidity?

Conventional wisdom suggests that increases in public information improve market liquidity. However, if greater public information incentivizes only sophisticated investors to produce private information, it could exacerbate information asymmetry among investors and thus reduce liquidity. We explore this argument on a sample of mortgage-backed securities (MBSs) by using a recent European regulation that mandates complex disclosures about the individual loans underlying MBSs. We find that the liquidity of the debt tranches of disclosed MBSs declines by 23% post-regulation. Our inferences are stronger when the securities are harder to value and when the disparity in investor sophistication is higher. In contrast to these findings, we also find that the disclosures increase the liquidity of the equity tranches of the same MBSs. Overall, our evidence implies that the liquidity impact of enhanced public information varies with the nature of the asset in question; this effect is likely a function of the investors’ incentives for information production and price discovery.

Aggregate Liquidity Premium and Cross-sectional Returns: Evidence from China

The Chinese stock market incurs huge illiquidity costs. Liquidity has different aspects but literature rarely measures it from an aggregate perspective. To capture liquidity along various dimensions and more consistently, we propose an aggregate liquidity premium with a partial least squares approach by aggregating information on 12 liquidity-related firm characteristics in the Chinese stock market. The aggregate liquidity predictor generates significantly higher expected stock returns than individual characteristics, remains robust to different information aggregation methods, and reflects the multidimensional feature of liquidity. Behavioral mispricing theory helps explain the aggregate liquidity premium because illiquidity limits arbitrage to correct mispricing. As liquidity is important and traditional factor models limitedly explain it, we develop a new-factor model to capture the aggregate liquidity premium. The aggregate liquidity premium in China indicates that policymakers should improve market liquidity.

Excess Cash and Equity Option Liquidity

This study examines the relationships between excess corporate cash holding and equity option market liquidity over the period from Jan 3, 2005 to Dec 31, 2019. We show that the level of cash reserve in excess of what can be captured by firm characteristics significantly explains the liquidity of stock options. Trading volume and open interests of the options increase in companies with a higher magnitude of excess cash while the bid-ask spreads of stock options decline in excess cash. Our findings confirm the theoretical predictions by Gopalan et al. (2012) that excess cash improves market liquidity as it reduces adverse selection problems caused by the uncertainty in firm valuations. This relation remains more pronounced with put options, out-of-the money contracts or those with short maturities. In addition, excess cash has stronger impacts on option liquidity within firms with a greater degree of informed trading or during periods of high volatility in financial markets. Our result shows that when the uncertainty about prospects of firms rises, excess cash becomes more valuable and affects option market liquidity.

Improving the liquidity of China's carbon market: Insight from the effect of carbon price transmission under the policy release

Abstract Through a series of policies release, the trading system of China's carbon market is being improved, but its current liquidity is still low. To improve market liquidity, this paper analyzes the relation between the release of policy related to carbon market operations and the volatility of carbon price, thus arranging an optimal adjustment scheme for government's policy-making. Through the jump test and Logit regression, we investigate historical policies and prices of 7 Emission Trading Scheme pilots in China to explore the impact of policy release on carbon price, and then quantify the effectiveness of these policies. Empirical results indicate that in the short-term, new policies can rapidly lead to a large volatility of carbon price, but it can also reduce the abnormal volatility with the spread of price information. Further, the demand-stimulus policies promote a positive volatility of carbon price. In the long-term, the insufficient demands for carbon emissions quota raise the disappearance of market dividends caused by the policy release and lead to an excessive call-back of carbon price, thus increasing mid-and long-term risks in carbon markets. Additionally, China's macro environment policy can stabilize carbon price, and thus an effective tool for improving the liquidity of carbon markets is developing demand-stimulus policies.

The decline in idiosyncratic values of US Treasury securities

Abstract Unique features and market frictions can lead to idiosyncratic pricing for some US Treasury securities. This study uses a linear programming (LP) model to measure aggregate idiosyncratic pricing of T-notes and T-bonds from 1980 to 2016. We document an average idiosyncratic pricing of $0.11 per $100 par, as compared to an average bid-ask spread of $0.08. Further, idiosyncratic pricing declined dramatically from the early 1980s to the 2010s. Empirical evidence suggests that the 1986 Tax Reform Act, increasing issue sizes and improving market liquidity contribute to the decline. At the individual security level, we identify factors contributing to and mitigating idiosyncratic pricing.

Implementation of Fama and French Five Factor Model: A Case of Pakistan Stock Exchange

The continuous development in the asset pricing is providing new empirical models and techniques to check the relationship between risk and return on stocks but it might be challenging to pick one model to use for the users. Investors and investment portfolio managers are always in search of such financial models that may quantify risk in an appropriate manner and can translate the risk into expected returns on equity investment options. Different models and techniques have been applied by the researchers and analysts from time to time to analyze this relationship; among them CAPM is the most famous and widely used technique. Later on, [1] extended the CAPM by adding two more factors in it; Size and Value. Subsequently, [2] introduced Five-Factors Pricing Model (FF5F); which is a development of the earlier models, by adding two new factors; investment level and profitability position. This study is intended to investigate whether a Fama and French five factor asset pricing model (FF5F) can explain average returns of stocks on Pakistan stock exchange (PSX) in a better way than the three factor model (FF3F) and CAPM or there is a need to include more factors in it. The study will be conducted on a sample of all listed non-financial firms’ stock with persistent trading on the PSX by constructing portfolios based upon basic factors identified by [3]. The analysis will be performed by regression analysis. This study will be helpful to the investors, investment advisers and fund managers to entrench their operating strategies and methodologies by adding the expounding power of size, beta, and value along with the momentum of portfolio returns to allow them to devise some trading policies to minimize losses and to maximize returns. In addition to this, policy makers can ensure that some proper measures are already in place to improve market liquidity and viability to improve the breadth and depth of the whole market.

Improving Liquidity in Secondary Spectrum Markets: Virtualizing Spectrum for Fungibility

Pricing mechanisms in the form of auctions have been the main method for spectrum assignment in the United States for over 20 years. The spectrum auctions carried out by the federal communications commission constitute a primary market for spectrum and have been affected by lack of flexibility which has resulted in inefficiencies in spectrum assignment, especially in environments where spectrum is considered scarce. In recent years, we have observed significant efforts to increase efficiency in spectrum assignment and use. Among those efforts is the design and adoption of secondary markets . Secondary markets have the potential to address inefficiencies arising in primary markets over time or those that occur through features of auction mechanisms by enabling spectrum to be assigned to users who value it the most. Furthermore, liquid secondary markets have enabled the explicit management of risk in other markets, such as agriculture and commodities, through futures and options trading. In this paper, we advance the study of liquidity in secondary markets that was begun in our previous work. We explore: 1) the reasons that may have hindered the emergence of liquid secondary markets for radio spectrum and 2) what we might change to promote secondary markets. With these objectives in mind, we study various configurations for the design of secondary markets, which account for the physical constraints inherent to electromagnetic spectrum. In addition, we study technical alternatives that would permit us to develop an appropriate, tradeable, and spectrum-related commodity. The results of our analysis show that lack of fungibility has an adverse impact on secondary market liquidity. To address this outcome, we propose virtualization of spectrum resources into fungible chunks and show that this improves market liquidity by yielding viable market outcomes in all the scenarios we tested.

Paying for Market Liquidity: Competition and Incentives

Do competition and incentives offered to designated market makers (DMMs) improve market liquidity? Using data from the NYSE Euronext Paris, we show that an exogenous increase in competition among DMMs leads to a significant decrease in quoted and effective spreads, mainly through a reduction in the realized spread. In contrast, changes in incentives, through small changes in rebates and requirements for DMMs, do not have any tangible effect on market liquidity. Our analysis shows that incentivizing DMMs might not necessary lead to an improvement of market liquidity unless exchanges induce greater competition among DMMs.

Capital-market effects of securities regulation: Prior conditions, implementation, and enforcement revisited

While it is not clear from Christensen, Hail, and Leuz (2016), the market abuse rules they examine are the same as in Cumming, Johan, and Li (2011), with a difference in focus on the date: Christensen et al. (2016) pick the date the regulations were signed into law, while Cumming et al. (2011) pick date the date the regulations were implemented with organizational agreements and computerized surveillance. Both papers study and find the exact same effect: regulatory change improves market liquidity. We explain the relative merits of the different approaches in this paper, and identify misleading statements in prior work.

Market fragmentation, liquidity measures and improvement perspectives from China's emissions trading scheme pilots

China's emissions trading pilots constitute an emerging and young commodity market. This paper compares the greater regional divergences of market rules and explores the impacts of market fragmentation and liquidity on emissions allowances prices in eight of China's emissions trading scheme (ETS) pilots using a Generalized Autoregressive Conditional Heteroskedasticity (GARCH) model with a generalized error distribution (GED). The Hubei, Guangdong and Shenzhen ETS pilots have obviously greater market shares and higher liquidity than the Beijing, Shanghai, Tianjin, Chongqing and Fujian ETS pilots. Market fragmentations have significant impacts on emissions allowance returns in the Beijing, Guangdong and Hubei ETS pilots; illiquidity ratios and trading values have significant influences on emissions allowance returns in the Beijing, Shanghai, Tianjin, Hubei and Fujian ETS pilots; and the variances in market fragmentation and liquidity in the Beijing, Shenzhen and Hubei ETS pilots have more persistent impacts on the variances in emissions allowance returns than the Shanghai, Tianjin, Guangdong and Chongqing ETS pilots. Greater market fragmentation, insufficient allowance transactions, longer trade intervals and poorer information transparency result in lower liquidity and pricing efficiency. Finally, some suggestions are offered to improve market liquidity and pricing efficiency in China's emissions trading scheme pilots.

Information and Liquidity of OTC Securities: Evidence from Public Registration of Rule 144A Bonds

The Rule 144A private debt represents a significant and growing segment of the U.S. bond market. This paper examines the market liquidity effects of enhanced information disclosure induced by the public registration of 144A bonds. Using the regulatory version of TRACE data for the period 2002-2013, we find that following public registration of 144A bonds, dealer-specific effective bid-ask spreads narrow, especially for issues with higher ex-ante information asymmetry. Our results are consistent with existing theories that disclosure reduces information risk and thus improves market liquidity.

Security market regulation: antecedents for capital market confidence in frontier markets

PurposeThe purpose of this study is to examine the capital market effects of corporate governance (CG) practices of a “comply or explain” environment on stock market liquidity in a frontier market.Design/methodology/approachUsing secondary data from Nairobi Securities Exchange, the liquidity position is analyzed using panel data random effects regression against CG guidelines.FindingsThe results show a negative and significant relationship between CG compliance and stock market liquidity, suggesting that regulated CG practices improve market liquidity in Kenya. The results are remarkably robust to different measures of liquidity and supports agency and signaling theory.Practical implicationsThe authors provide evidence to show that security regulation improves stock market liquidity in a frontier market whose characteristics are thought not to favor regulation. Therefore, regulators and stakeholders could be motivated by the benefits of regulation, and this could lead to renewed effort to improve CG compliance.Originality valueThe findings show that security market regulation through CG guidelines can improve stock market liquidity in frontier markets. This offers regulators and policymakers a strong motivation to enhance security regulation to improve capital market confidence.

Scarcity Effects of Quantitative Easing on Market Liquidity: Evidence from the Japanese Government Bond Market

Quantitative easing could improve market liquidity through many channels such as relaxing bank funding constraints, increasing risk appetite, and facilitating trades. However, it can also reduce market liquidity when the increase in the central bank’s holdings of certain securities leads to a scarcity of those securities and hence higher search costs in the market. Using security-level data from the Japanese government bond (JGB) market, this paper finds evidence of the scarcity (flow) effects of the Bank of Japan (BOJ)’s JGB purchases on market liquidity. Moreover, we also find evidence that such scarcity effects could dominate other effects when the share of the BOJ’s holdings exceeds certain thresholds, suggesting that the flow effects may also depend on the stock.