Liquidity Costs Research Articles

Liquidity phenomenon: Essence, criteria, properties and impact on the market and investment value of assets

The paper is devoted to the study of the "liquidity" phenomenon from the standpoint of the economic and mathematical approach. The existing definitions are presented, as well as four criteria of liquidity and one criterion of illiquidity. Theoretical analysis of the properties of liquidity was carried out. Particular attention is paid to such transaction costs as spread and time factor. It is shown that liquidity is not an immanent category of an asset — it is a derivative of several factors characteristic of both the asset and its market environment. Based on the analysis, a microeconomic condition for emergence of liquidity phenomenon, possible methods and ways of identifying the degree of liquidity, as well as methods for assessing liquidity costs are proposed. Additionally, methods are proposed for assessing the economic benefits of liquidity and their contribution to the cost of similar and different assets. To assess the individual benefits of liquidity, the concepts of "equalizing rate" and "compensatory equivalent" were introduced, which are subsequently integrated into the methodology for assessing total and additional liquidity, expressed in relative or absolute (monetary) forms. The final part presents the classification of liquidity types, its combination with the investment value of liquid and illiquid assets, as well as an example of an end-to-end calculation of the proposed values. The appendix contains calculation formulas for assessing liquidity costs. The methodology of calculations proposed in the article can be applied when assessing the investment attractiveness of assets, choosing options for placing assets in the form of cash, securities or real estate.

Quantifying the economic benefits of payments modernization: the case of Canada’s large-value payment system

In this paper, we develop a discrete-choice framework to quantify the economic benefits of Canada’s large-value payment system modernization (ie, the replacement of Canada’s large-value transfer system (LVTS) with Lynx, the new large-value payments system in Canada). We first estimate participants’ preferences for liquidity cost, payment safety and the network effect by exploiting intraday variations in the relative choice probabilities of the two substitutable subsystems (tranches 1 and 2) in the LVTS. Then, with the estimated model, we calculate the changes in participants’ welfare when the LVTS is replaced by Lynx. First, compared with the LVTS, Lynx has higher liquidity costs but is more secure. Second, when over 90% of current LVTS payments migrate to Lynx, there is an overall welfare gain. Third, accounting for equilibrium adjustment after the replacement of the LVTS with Lynx, about a 75% improvement in service quality level is needed to generate overall net economic benefits to participants. Among other things, adopting a liquidity-saving mechanism and reducing risks in the new large-value payments system could help achieve this improvement. Finally, the welfare changes are fairly heterogeneous across participants, especially between large and small participants.

Approximation and comparison of the empirical liquidity cost function for various futures contracts

The article is dedicated to the study and comparison of the empirical liquidity cost function for various futures contract. The function is determined by the current state of the limit order book (LOB). Comparing the liquidity cost of futures contracts, we suggest the use of the initial margin instead of the number of lots or asset units. The form of the empirical liquidity cost function is obtained and a number of approximations for practical use are proposed. The approximations were achieved by quadratic, linear and power functions. The explanation of the difference in the distribution of the values of the liquidity cost function depending on the required initial margin is proposed. These results can be used for optimal execution of large orders, including portfolio hedging.

A New Method to Analyze the Mine Liquidation Costs in Poland

Coal mine closure processes are being carried out in the European Union due to the current energy transition. The use of coal-fired power plants has been significantly reduced in recent years. Because of the significant financial outlays, processes of rationalization and minimization of the mine liquidation cost should be carried out. In this paper, a statistical analysis of the liquidation processes in hard coal mines in Poland was carried out. A new tool was developed in order to optimize the mine liquidation costs. The mine liquidation process can be divided into ten different processes, which have been analyzed in detail in this research work. The method of the assessment of the amount of estimated liquidation costs described is based on the analysis of the total liquidation cost. The presented method of signaling deviations of the costs of the liquidation of the mining plant from the average value is a useful tool in the process approach to the issues connected with the restructuring of post-industrial property. The presented cost assessment procedure may facilitate the monitoring of conducted activities in terms of rationalization and minimization of the costs incurred. Finally, the proposed method for assessing the cost of mine liquidation is understandable, simple, and easy to use for applications in preliminary design works and on-going engineering works.

Liquidity, Profitability and Operational Costs on Corporate Income Tax

Tax revenue is the largest source of income for the Indonesian state. One of the contributors to state revenue from the tax sector is corporate income tax. Financial performance is one measure of the success of a business entity which is expected to increase revenue from corporate income tax. This study aims to determine the effect of financial performance using variable liquidity ratios, profitability ratios, and operating costs on corporate income tax. The data used is secondary data, namely annual financial report data from large trading sub-sector companies (wholesale) listed on the Indonesia Stock Exchange (IDX) for the 2014-2018 period. The analytical method used is multiple regression analysis. The results showed that partially profitability and operating costs have an effect on corporate income tax, while liquidity has no effect on corporate income tax. Simultaneously, liquidity, profitability and operating costs affect corporate income tax. Based on the results obtained that the ratio that affects corporate income tax is profitability and operating costs, so as an implication the internal party/management must be careful with the information presented in the financial statements which will have a negative impact on the users of financial statements, especially on operating costs.

Foreign Banks, Liquidity Shocks, and Credit Stability

Abstract This paper investigates whether foreign banks help mitigate the effects of domestic liquidity shocks by exploiting a policy-induced shock to the U.S. wholesale market for liquidity and matched bank-syndicated loan data. We find that, following the 2011 Federal Deposit Insurance Corporation (FDIC) regulatory change to the cost of wholesale liquidity, foreign banks, which faced a relatively positive liquidity shock, accumulated more reserves by engaging in liquidity hoarding, but did not expand their lending. These responses are more pronounced for foreign banks affiliated with complex global bank holding companies and whose parent banking systems experienced distress at the moment of the shock. (JEL G21, G28, E44) Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Why Are Banks Exposed to Monetary Policy?

We propose a model of banks’ exposure to movements in interest rates and their role in the transmission of monetary shocks. Since bank deposits provide liquidity, higher interest rates allow banks to earn larger spreads on deposits. Therefore, if risk aversion is higher than one, banks’ optimal dynamic hedging strategy is to take losses when interest rates rise. This risk exposure can be achieved by a traditional maturity-mismatched balance sheet and amplifies the effects of monetary shocks on the cost of liquidity. The model can match the level, time pattern, and cross-sectional pattern of banks’ maturity mismatch. (JEL E43, E44, E51, E52, G21, G32)

Quantifying the High-Frequency Trading “Arms Race”

Abstract We use stock exchange message data to quantify the negative aspect of high-frequency trading, known as “latency arbitrage.” The key difference between message data and widely familiar limit order book data is that message data contain attempts to trade or cancel that fail. This allows the researcher to observe both winners and losers in a race, whereas in limit order book data you cannot see the losers, so you cannot directly see the races. We find that latency arbitrage races are very frequent (about one per minute per symbol for FTSE 100 stocks), extremely fast (the modal race lasts 5–10 millionths of a second), and account for a remarkably large portion of overall trading volume (about 20%). Race participation is concentrated, with the top six firms accounting for over 80% of all race wins and losses. The average race is worth just a small amount (about half a price tick), but because of the large volumes the stakes add up. Our main estimates suggest that races constitute roughly one-third of price impact and the effective spread (key microstructure measures of the cost of liquidity), that latency arbitrage imposes a roughly 0.5 basis point tax on trading, that market designs that eliminate latency arbitrage would reduce the market’s cost of liquidity by 17%, and that the total sums at stake are on the order of $5 billion per year in global equity markets alone.

Towards a post-pandemic policy framework to manage climate-related financial risks and resilience

ABSTRACT All G20 countries have adopted policies to tame financial instability in response to the COVID-19 pandemic. Post-pandemic financial measures are designed to support bank lending, boost financial markets’ liquidity, reduce banks’ funding liquidity costs, and allow for a smoother transition in monetary and fiscal policies. However, when analyzed in a broader framework that considers possible interlinkages between the pandemic and threats posed by climate change, these measures are not aligned with the goals of the Paris Agreement. Indeed, there is no evidence that recovery policies to date reflect sustainability priorities nor do they account for climate-related financial risks. The analysis carried out suggests that this failure to account for climate change could amplify the build-up of additional climate-related financial risks and of existing vulnerabilities in the financial system, leading to increased overall exposure to climate risks and thus undermining the low-carbon transition in G20 countries. Against this backdrop, the paper reviews several financial measures to avoid increasing the high carbon bias of existing policies and to explicitly address climate-related risks in the financial sector. The author proposes an enhanced macro-prudential policy framework to achieve three interrelated objectives: tackle climate-related financial risks, scale up green finance for a greener and more sustainable recovery, and preserve the global financial system’s resilience. Key policy insights A macro-prudential strategy aligned with the goals of the Paris Agreement is needed to address carbon bias, avoid the increase of climate-related financial risks, and reorient financial flows towards sustainable investments. ‘Green-enhanced’ capital requirements can be used, but they need careful calibration to prevent financial instabilities, while green liquidity instruments pose fewer implementation concerns. Climate-related large exposure limits could help contain systemic risks deriving from the materialization of climate risks. Harmonized taxonomy and enhanced climate-related disclosure requirements are critical for the correct functioning of proposed climate-related financial instruments. Implementing such instruments in a post-pandemic financial policy framework could help underpin a transformative financial response to climate change while strengthening the resilience of the global financial system.

Fixed-Income ETFs: A liquidity illusion?

Exchange-Traded Funds (ETFs) have revolutionised the asset-management industry with high liquidity and low bid-asks allowing investors to access a diversified portfolio cheaply. The desirable liquidity characteristics of ETFs are, however, in contrast with their behavior in crisis periods. This paper studies the breakdown in the fixed-income ETFs (FIETFs) market, during the peak of the COVID-19-driven liquidity shock of March 2020. We argue that FIETFs provide an illusion of liquidity and the liquidity mismatch between the ETF and the underlying manifests itself in terms of very significant differences between the price and the Net Asset Value (NAV). We run a further analysis on the dislocation by comparing it with equity ETFs. Comparisons suggest that the cost of liquidity is very high for fixed-income ETFs with significant tracking errors during volatile periods in contrast with the better-behaved equity ETFs. Further analysis on the performance patterns of FIETFs indicates that both the price and NAV might have deviated from fundamentals with an overreaction in the ETF price accompanying an underreaction in the NAV. We also study the phenomena of ‘dealer inventory management’. FIETFs are uniquely different from equity ETFs in that the authorised participant (arbitrageurs) tend to be the large banks that are also market-makers in the underlying securities. Therefore, we show that the incentives of the arbitrageurs may not always be aligned towards arbitraging the price-NAV differential. In a novel empirical study using trading volumes and position changes for the largest corporate bond ETF (LQD), we suggest that inventory management by the larger broker-dealers may have exacerbated the dislocation. We believe that the conflicting objectives of dealers have further increased due to high balance-sheet costs imposed upon them post the Global Financial Crisis. Finally, we propose the use of derivatives, in particular credit derivatives, for the risk management of liquidity shocks. We show that the drawdown from rapid liquidity shocks can be reduced significantly through exposure to credit convexity.

An Application of Shapley Value Cost Allocation to Liquidity Savings Mechanisms

This paper describes a proposal for operating a centralized netting queue for nonurgent interbank payments that involves take-it-or-leave-it offers and allocates liquidity costs using the Shapley value. This method achieves fairness and ensures welfare-maximizing netting proposals are agreeable to all providers of liquidity.

Treasury Single Account and Fraud Management in Nigeria: Benefits and Challenges

Treasury systems are designed to manage several critical aspects of public expenditure management. Key treasury system functions include financial planning, control of the budgetary process and management of government cash flow. However, for any treasury system to be effective, government has to ensure that it has sufficient liquidity to deal with payments, while ensuring that such liquidity costs are kept within the barest minimum. TSA is a (system of) unified structure of government bank accounts enabling optimal utilization and consolidation of government cash resources. In TSA a bank account or a set of linked bank accounts is used for all government transactions all its receipts and payments and gets a consolidated view of its cash position at any given time. This study investigates Treasury Single Account (TSA) and Fraud Management: Benefits and Challenges in Nigeria. Adopting a survey design, the study made use of primary data collected mainly through administering a set of questionnaire to104employeesofselected three Corporate Affairs Commissions in South-East, Nigeria comprising Enugu, Imo and Abia.100copiesofthequestionnaireoutof the total number of retrieved copies of questionnaire were validly completed and useful for analyses. Findings interlaid revealed that: TSA significantly reduced the incidence of fraud in public enterprises; TSA in public enterprises to a large extent reduces the credit creation of deposit money banks. The study recommends that the TSA policy will be effective if, the Fiscal Sunshine Bill is to be put in place, and if enacted will open up all financial activities of government in a way that there will be no more hiding place for those who divert or loot government money. Just like the Fiscal Sunshine Act is in place with budgeting process, implementation and contract awards, should be open for Nigerians to see how both revenues are generated and how public money is being spent by those in government, and why; Government should overhaul the capacity of the Federal Ministry of Finance and the CBN in order to cope effectively with the challenges associated with enforcement of the provisions of the TSA.

The impact of long-term riskless asset on ensuring liquidity and preventing banking fragility

PurposeThrough portfolio diversification, the author identifies the risk sharing deposit contract in a three-period model that maximizes the ex ante expected utility of depositors.Design/methodology/approachIn this paper, the author extends the study by Allen and Gale (1998) by adding a long-term riskless investment opportunity to the original portfolio of a short-term liquid asset and a long-term risky illiquid asset.FindingsUnlike Allen and Gale, there are no information-based bank runs in equilibrium. In addition, the model can improve consumers' welfare over the Allen and Gale model. The author also shows that the bank will choose to liquidate the cheaper investments, in terms of the gain-loss ratios for the two types of existing long-term assets, when there is liquidity shortage in some cases. Such a policy reduces the liquidation cost and enables the bank to meet the outstanding liability to depositors without large liquidation losses.Originality/valueThe author believe that the reader would be interested in this article because it is relevant to real world where depositors rush to withdraw their deposits from a bank if there is negative information about future prospect of the bank asset portfolio and bank investment. Economists and financial analysts need to determine the suitable mechanism to improve the stability of the bank and the depositor welfare.

Payments on digital platforms: Resiliency, interoperability and welfare

Digital platforms, such as Alibaba and Amazon, operate an online marketplace to facilitate transactions. This paper studies a platform’s business model choice between accepting cash and issuing tokens, as well as the implications for welfare, resiliency, and interoperability. A cash platform free rides on the existing payment infrastructure and profits from collecting transaction fees. A token platform earns seigniorage, albeit bearing the costs of setting up the system and holding reserves to mitigate the cyber risk. Tokens earn consumers a return, insulating transactions from the liquidity costs of using cash, but also expose them to the remaining cyber risk. The platform issues tokens if the interest rate is high, the platform scope is large, and the cyber risk is small. Unbacked floating tokens with zero transaction fees or interest-bearing stablecoins can implement the equilibrium business model, which is not necessarily socially optimal because the platform does not internalize its impacts on off-platform activities. The model explains why Amazon does not issue tokens, but Alipay issues tokens circulatable outside its Alibaba platforms. Regulations such as a minimum reserve requirement can reduce welfare.

Network risk and key players: A structural analysis of interbank liquidity

Using a structural model, we estimate the liquidity multiplier of an interbank network and banks’ contributions to systemic risk. To provide payment services, banks hold reserves. Their equilibrium holdings can be strategic complements or substitutes. The former arises when payment velocity and multiplier are high. The latter prevails when the opportunity cost of liquidity is large, incentivising banks to borrow neighbors’ reserves instead of holding their own. Consequently, the network can amplify or dampen shocks to individual banks. Empirically, network topology explains cross-sectional heterogeneity in banks’ systemic-risk contributions while changes in the equilibrium type drive time-series variation.

Network Risk and Key Players: A Structural Analysis of Interbank Liquidity

Using a structural model, we estimate the liquidity multiplier of an interbank network and banks’ contributions to systemic risk. To provide payment services, banks hold reserves. Their equilibrium holdings can be strategic complements or substitutes. The former arises when payment velocity is high and payments begets payments. The latter prevails when the opportunity cost of liquidity is large, incentivising banks to borrow neighbors’ reserves instead of holding their own. Consequently, the network can amplify or dampen individual shocks. Empirically, network topology explains cross-sectional heterogeneity in banks’ contribution to systemic risks while changes in the equilibrium type drive the time-series variation.

Deep reinforcement learning for the optimal placement of cryptocurrency limit orders

This paper presents the first large-scale application of deep reinforcement learning to optimize execution at cryptocurrency exchanges by learning optimal limit order placement strategies. Execution optimization is highly relevant for both professional asset managers and private investors as execution quality affects portfolio performance at economically significant levels and is the target of regulatory supervision. To optimize execution with deep reinforcement learning, we design a problem-specific training environment that introduces a purpose-built reward function, hand-crafted market state features and a virtual limit order exchange. We empirically compare state-of-the-art deep reinforcement learning algorithms to several benchmarks with market data from major cryptocurrency exchanges, which represent an ideal test bed for our study as liquidity costs are relatively high. In total, we leverage 18 months of high-frequency data for several currency pairs with 300 million trades and more than 3.5 million order book states. We find proximal policy optimization to reliably learn superior order placement strategies. By interacting with our simulated limit order exchange, it learns cryptocurrency execution strategies that are empirically known from established markets. Order placement becomes more aggressive in anticipation of lower execution probabilities, which is indicated by trade and order imbalances.

Liquidity costs on intraday power markets: Continuous trading versus auctions

We analyze liquidity costs on continuous and auction-based intraday power markets using a cost-of-round-trip measure that works for both market designs. We use data from the Italian auction-based intraday market and the German continuous market and present descriptive statistics as well as multivariate regression models to analyze determinants of liquidity costs in both markets. To test for differences in liquidity due to market design, we employ a double machine learning technique controlling for several confounding variables. We show that weekly patterns, yearly seasonality, electricity demand, as well as the influence of temperatures significantly affect liquidity costs. Comparing liquidity costs in both market, we find that, overall, liquidity costs are lower on the Italian market. However, Italian costs increase towards later auctions, while the costs on the German continuous intraday market decrease and reach their low close to physical delivery, where costs are lower than on the last Italian market trading the corresponding products.

Liquidity in competitive dealer markets

AbstractWe study a continuous‐time version of the intermediation model of Grossman and Miller. To wit, we solve for the competitive equilibrium prices at which liquidity takers' demands are absorbed by dealers with quadratic inventory costs, who can in turn gradually transfer these positions to an exogenous open market with finite liquidity. This endogenously leads to transient price impact in the dealer market. Smooth, diffusive, and discrete trades all incur finite but nontrivial liquidity costs, and can arise naturally from the liquidity takers' optimization.

A study on tax issues that may arise in relation to real estate in case of qualified acceptance

There are lots of practical and theoretical problems in case of qualified acceptance, especially in relation to real estate. For exemple, think about that question ; After the inheritee set a mortgage on real estate A and died, one of inheritors filed a report of qualified acceptance. Discretionary auction on real estate A proceeded, and successful bidder paid price at official auction. Then inheritee’s creditor received dividend from that auction. Should inheritors pay for transfer income tax of real estate A, despite qualified acceptance of one of inheritors? Jugements of lower courts and decisions of Tax Tribunal are lack of consistency and not unified. For the reason that qualified Acceptance is under the condition of repaying the obligation of inheritee, it is important to know when the transfer is in terms of transfer income tax. If there was a transfer prior to the inheritee’s death, the obligation of transfer income tax is that of inheritee. On the other hand, if there was a transfer after the inheritee’s death, the obligation of transfer income tax is that of inheritor. That is due to the text of Civil Act Article 1028. In this case, Civil Act Article 998-2 can be applied to transfer income tax. Expenses for inheritance on Civil Act Article 998-2 can include liquidation cost that is for settling the liability of transfer income tax of inheritee. There is an acquisition tax when an inheritor acquires real estate due to inheritance. However, since inheritors are already required to pay inheritance tax, there is a double taxation for inheritors to pay the acquisition tax. Inheritance tax shall be included in the expense of inheritance under Article 998-2 of Civil Act because the estate tax method is adopted and the estate tax method levies on the property of inheritee. Since the inheritance tax is the obligation of the inheritee, it is reasonable to assume that inheritors should not be liable for the qualified acceptance. A renunciation of an inheritance may be used to exempt all obligations arising from inheritance. If there is a risk of tax liability incurred despite filing a report of qualified acceptance, a renunciation of an inheritance should be considered within the statutory period.