Improve Market Liquidity Research Articles

Changing Market Perceptions of Who is ‘Too Big to Fail’ During the Financial Crisis of 2007-2008

The government support of financial firms through direct assistance and programs to improve market liquidity during the worldwide financial crisis of 2007-2008 is unprecedented since the Great Depression. Whether a given firm is ex-ante ‘Too Big To Fail’ in the mind of government agents is not the principal issue for moral hazard, however. It is investor perception of ‘Too Big To Fail’ that drives the economically inefficient reduced funding cost for the firm. This work examines the U.S. government’s crisis actions as well as two international bank bailouts in a series of event studies employing both debt and equity returns. Other than in the case of private mortgage insurer, Radian, in response to explicit support of Fannie Mae and Freddie Mac, I conclude that only the largest of the banks and the government sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, already perceived to be recipients of explicit or implicit government guarantees, experienced any ‘Too Big To Fail’ premiums in their debt securities. There is no evidence that these premiums extended to other large financial firms such as broker dealers, non-mortgage insurers or surety firms, in spite of the bailout of Bear Stearns. There is no evidence that letting Lehman Brothers fail was a surprise to investors. In addition, there is no evidence that AIG’s large derivative exposures and their associated losses prior to and during the crisis led investors to infer it would be rescued. Federal Reserve programs to improve liquidity and extend lending to non-banks did not lead to ‘Too Big To Fail’ premiums for firms.

'Shooting the Messenger?' The Impact of Short Sale Bans in Times of Crisis

We find that the bans on covered short sales, implemented in several countries during the financial crisis of 2008-09 improved market liquidity or at least had a neutral impact; a result we argue could be expected in theory, given a simple variation on the Diamond-Verrechia (1987) model. The result holds for daily data over an extended period as well as for intraday data over various time spans. In contrast to other recent studies, we use American Depository Receipts as the controls in a difference-in-difference analysis encompassing all banned non-U.S. shares with corresponding depository receipts listed in the United States. Furthermore, we find that bans on covered short sales generally succeeded in lowering volatility. Banning short selling is not good policy in normal times, but our findings indicate that such bans might prove useful in (temporarily) stemming liquidity loss during crises.

Ownership dispersion and market liquidity

We revisit the relationship between ownership dispersion and market liquidity. For ownership dispersion, we consider two dimensions: number of shareholders and blockholder ownership. For market liquidity, we consider four categories of liquidity measures: spreads, probability of informed trading (PIN), depth, and volume. Our sample includes NASDAQ firms in addition to NYSE and AMEX firms. We find several relations that are not documented in the extant Finance literature. Overall, our test results are consistent with the idea that higher ownership dispersion improves market liquidity.

United Kingdom gilt securities and market liquidity: surveying the impact of structural reforms

PurposeBetween 1996 and 1998, the Bank of England (BoE) undertook structural reforms of the UK gilt market designed to improve market liquidity and accessibility. The purpose of this paper is to ascertain, through the use of a market survey, whether the broad aims of the reforms were achieved.Design/methodology/approachThe research technique used in the paper is direct qualitative survey evidence of the market. It is considered that part of the impact of any structural reform is how the market responds to it. Hence, the actual views of the market are relevant, and this highlights the value of conducting a market survey.FindingsSurvey evidence suggests that the reforms were welcomed by market practitioners, and that perceived levels of liquidity had increased in the period following the reforms. From the survey results, it cannot be concluded unequivocally that the reforms led to higher liquidity. Nevertheless, the responses to the critical questions of liquidity and price spread provided evidence that an improvement in market conditions was perceived to have occurred.Practical implicationsThe survey results suggest that dealing and settlement efficiency in a government bond market is of value to investors. Therefore, BoE‐style reforms may be considered for implementation in other sovereign bond markets.Originality/valueThe paper is the first direct survey of the UK gilt market, and the first study into the impact of the BoE reforms on market liquidity. As such, it may be of value to sterling market investors as well as the central monetary authorities.

The information content of stock splits

Abstract This study examines whether stock splits contain information content about future operating performance or whether splits are undertaken by firms to realign their share prices and to improve trading liquidity. In the four years following split announcements, splitting firms do not experience improved operating performance relative to non-splitting firms. Furthermore, stock split signals are not related to future profitability. The positive announcement effect can be explained by lower share prices and improved market liquidity following stock splits but not by split signals and post-split operating performance. Our results show very little evidence that stock splits signal improvement in long-run operating performance and are more consistent with the trading range/liquidity hypothesis.

The Rise and Fall of Portfolio Pumping Among U.S. Mutual Funds

Fund managers have incentives to inflate their quarterly performance by aggressively buying stocks they already own. Using intraday measures of pumping we document that sharply increased regulatory attention in late 2000 and improved market liquidity following the implementation of Regulation NMS in 2007 are associated with fewer last-minute purchases by institutions, lower price spikes in mutual fund NAVs, and a weakened link between fund holdings and stock return reversals at period ends. Our findings suggest that portfolio pumping among U.S. mutual funds was widespread until regulatory scrutiny and heightened competition drastically diminished its prevalence.

Linkage of Tradable Permit Systems in International Climate Policy Architecture

Cap-and-trade systems have emerged as the preferred national and regional instrument for reducing emissions of greenhouse gases throughout the industrialized world, and the Clean Development Mechanism — an international emission-reduction-credit system — has developed a substantial constituency, despite some concerns about its performance. Because linkage between tradable permit systems can reduce compliance costs and improve market liquidity, there is great interest in linking cap-and-trade systems to each other, as well as to the CDM and other credit systems. We examine the benefits and concerns associated with various types of linkages, and analyze the near-term and long-term role that linkage may play in a future international climate policy architecture. In particular, we evaluate linkage in three potential roles: as an independent bottom-up architecture, as a step in the evolution of a top-down architecture, and as an ongoing element of a larger climate policy agreement. We also assess how the policy elements of climate negotiations can facilitate or impede linkages. Our analysis throughout is both positive and normative.

Prospect Theory and Market Liquidity

We study equilibrium trading strategies, market liquidity, and price efficiency in an economy in which a fraction of better-informed speculators displays preferences consistent with Kahneman and Tversky’s (1979) Prospect Theory, i.e., loss aversion, risk seeking over losses, and nonlinear and asymmetric probability weighting (in the spirit of Jullien and Salanie, 2000). Loss aversion induces those speculators to trade more cautiously, while risk seeking induces them to trade more aggressively, with their private signals. We demonstrate that the latter effect dominates the former in equilibrium, leading to lower and (because of procyclical subjective loss probabilities) countercyclical adverse selection-based market liquidity and higher price efficiency. We also find that the presence of those speculators affects the extent to which the release of public news about the traded asset’s terminal payoff improves market liquidity and price efficiency and makes such improvement procyclical. JEL classification: D82; G14

Ownership structure and stock liquidity: Some evidence from the Jordanian capital market

It is common knowledge that the microstructure of securities markets has generated a large number of research papers. This effort is not really surprising if one understands that market liquidity is important because of its implications for firms’ investment and financing decisions and the development of financial markets. This paper examines the issue of stock liquidity in the Jordanian capital market. Specifically, we provide of measure of liquidity cost and relate it to firm specific characteristics including the ownership structure of stocks. Based on the daily trading data for a total of 131 listed companies during 2005, the results indicate that liquidity cost in the Jordanian market is high. In addition, the results indicate that while risk is the main determinant factor of spread, higher ownership dispersion does not improve market liquidity.

Disclosure Policy and Market Liquidity: Impact of Depth Quotes and Order Sizes*

AbstractThis paper investigates the relation between disclosure policy and market liquidity. Our tests examine two key aspects of market liquidity, the effective bid‐ask spread and quoted depth, and how they relate to financial analysts' ratings of firms' disclosure policies. We introduce a method of combining order sizes and depth quotes to yield more precise estimates of effective spreads on trades likely constrained by quoted depth. We find that while firms with higher rated disclosures are charged lower effective spreads, they are also quoted lower depth, consistent with the notion that better disclosures reduce information asymmetry but also cause some liquidity suppliers to exit the market. Therefore, a simple examination of spreads and depths yields ambiguous inferences on the relation between disclosure policy and market liquidity. We resolve this ambiguity by estimating depth‐adjusted effective spreads, and find that firms with higher rated disclosures have lower depth‐adjusted effective spreads across all trade sizes. Consequently, our results reveal a robust inverse relation between disclosure ratings and effective trading costs. This implies that a policy of enhanced financial disclosure is related to improved market liquidity.

A survey of market practitioners’ views on exchange rate dynamics

We report some findings from a survey of practitioners in the interbank foreign exchange markets in Hong Kong, Tokyo, and Singapore. The respondents contend that liquidity and market uncertainty are two important reasons for deviating from the conventional interbank bid-ask spread. A strong customer base is perceived as a source of competitive advantage for large participants. Most respondents agree that non-fundamental factors have pervasive impacts on short-run exchange rates. Speculation is believed to increase volatility but also improve market liquidity and efficiency. Despite their claim that intervention exacerbates volatility, more than one-half of the respondents suggest official intervention helps restore equilibrium.