Liquidity Costs Research Articles

The Synthetic Cost of Liquidity

We propose a new approach to model the cost of liquidity based on the synthetic replication of the sale of a liquid asset. Assuming that markets are complete, the sale of a liquid asset can be replicated by a) taking the decision to sell an illiquid asset and effectively sell it at a later date at its fair value b) borrowing cash until the sale is completed and c) short-selling an equivalent liquid asset or portfolio of assets in order to cancel out the economic exposure over the same period. The synthetic replication implies that the cost of liquidity should equal the investor's credit spread plus the securities lending cost or cost of borrow, accounting for the time to liquidate and the holding period. The model produces annualized liquidity cost that can range from a few basis points for liquid stocks to 60bps for real estate and up to 3% for illiquid assets such as infrastructure or private equity. This approach links market and funding liquidity measures and can explain contagion of liquidity crisis among asset classes as well as the absence of liquidity premium in the presence of investors with little funding constraints such as pension funds and soverign wealth funds.

LOCAL RISK-MINIMIZATION WITH MULTIPLE ASSETS UNDER ILLIQUIDITY WITH APPLICATIONS IN ENERGY MARKETS

We propose a hedging approach for general contingent claims when liquidity is a concern and trading is subject to transaction cost. Multiple assets with different liquidity levels are available for hedging. Our risk criterion targets a tradeoff between minimizing the risk against fluctuations in the stock price and incurring low liquidity costs. We work in an arbitrage-free setting assuming a supply curve for each asset. In discrete time, we prove the existence of a locally risk-minimizing strategy under mild conditions on the price process. Under stochastic and time-dependent liquidity risk we give a closed-form solution for an optimal strategy in the case of a linear supply curve model. Finally we show how our hedging method can be applied in energy markets where futures with different maturities are available for trading. The futures closest to their delivery period are usually the most liquid but depending on the contingent claim not necessarily optimal in terms of hedging. In a simulation study, we investigate this tradeoff and compare the resulting hedge strategies with the classical ones.

The Time Variation of Liquidity Risk on US Stock Markets

Abstract The influence of liquidity costs and liquidity risk on asset returns has been proven by several empirical studies. This paper analyzes the conditional version of the liquidity-adjusted capital asset pricing model and shows that betas significantly vary over different economic regimes and that liquid portfolios provide diversification benefits compared with illiquid portfolios. The results support the effects of a flight-to-liquidity. The time variation of liquidity betas induces additional risk for investors, which has important implications for investment decisions and asset allocation. Die Zeitschwankung des Liquiditatsrisikos in US-Aktienmarkten Zusammenfassung Der Einfluss von Liquiditatskosten und Liquiditatsrisiko auf die Renditen verschiedener Assets wurde bereits durch einige Studien belegt. Dieses Paper untersucht das conditional liquidity-adjusted capital asset pricing model und zeigt, dass die Liquidity-Betas signifikant uber verschiedene Marktphasen hinweg schwanken und dass liquide P...

Executive Network Centrality and Stock Liquidity

We examine the relationship between stock market liquidity and the network centrality of firm executives. We find that firms whose executive officers are more central in the network of executives have narrower spreads and reduced stock liquidity costs. We use an exogenous network centrality shock of executive turnover and report that liquidity improves after firms hire executives with greater centrality. We present evidence that improved liquidity is attributable to efficient information flows around executives in more advantageous network positions.

Credit Risk, Liquidity, and Bubbles

This paper presents an arbitrage-free valuation model for a credit risky security where credit risk coexists and interacts with an asset price bubble and liquidity risk (or liquidity costs). As an illustration, this model is applied to determine the fair rate for microfinance loans.

Index Revisions, Stock Liquidity and the Cost of Equity Capital

This study examines the stock liquidity and cost of equity capital (COEC) effects around the CNX Nifty index revisions during the period 1998–2011. To examine these effects, the inclusion (exclusion) firms are compared with their matching peers. The stock liquidity effect has been examined by using distinct liquidity measures, such as trading volume, turnover rate and illiquidity ratio. The COEC effect has been examined with the help of cost of equity, stock liquidity, firm size, leverage and inclusion (exclusion) dummies. It was found that the stocks included to the CNX NIFTY were less liquid than their matching peers were, whereas the stocks excluded were experiencing more liquidity than their matching peers. Further, the study finds an increase in the COEC for the included firms and a decrease in the COEC for the excluded firms.

Influence of different concentrations of ionic solutions on coal spontaneous combustion

ABSTRACTConsidering the high cost of ionic liquids, this paper proposed to dilute ionic liquids with purified water to suppress coal spontaneous combustion based on an in-depth study on the mechanism of ionic liquids for suppressing coal spontaneous combustion. Three kinds of ionic liquids, namely, [HOEMIm][BF4] (HOE), [BMIm][BF4] (BM), and [AMIm]Cl (AM), were mixed with purified water to form ionic solutions with different concentrations. The differences in gas products of raw coal and samples treated with ionic solutions were comparatively analyzed, and then their mechanism of inhibiting coal spontaneous combustion was studied by calculating inhibition rates and apparent activation energy of samples. Furthermore, the molecular structure of coal was further studied by means of Fourier transform infrared spectroscopy. The results show that ionic solutions can not only absorb heat through water evaporation, but also reduce the alkyl chain content of coal by inerting hydrogen bonds in coal. Among the three kinds of ionic solutions with different concentrations, AM with a mass ratio of 1:10 achieves the best inhibitory effect.

'Operational Risk and Its Determinants': A Study on Logistics and Tranportation Industry in Malaysia

Operational risk can caused by both internal and external factors, which is probably due to the inefficient management or breakdowns in internal procedures, human errors and systems failures. It is important for an organisation to manage operational risk efficiently. This study aims to investigate the influence of firm-specific factors and macro-economic factors affecting operational risk among five selected logistics company in Bursa Malaysia. Multiple regression analysis of financial ratios of the five selected companies is conducted for the year from 2012 to 2016. The findings and analysis shows that firm-specific factors (quick ratio and average collection period) have a greater influence on operational risk of the company as compared to macro-economic factors. This study also suggest that it is necessary for a firm to manage its liquid assets in an optimum way and minimizing the cost of liquidation, in order to have sufficient cash flow for business operations. Besides, the company should manage its account receivables efficiently in order to reduce operational risk. This can be achieved by establishing clear credit policies, tracking credit history of new customers, and setting clear payment terms.

Stress Testing of Liquidity Maturity Transformation Risk in Banks

One of the main causes of the past crisis was the inability of financial institutions to acquire funding at appropriate costs. The importance of applying a good liquidity risk measurement system becomes apparent. The present paper provides an approach to the measurement of liquidity maturity transformation risk within a stress testing framework, for middle-sized banks. The costs of liquidity arising due to a downturn in refinancing conditions are calculated by using modern risk measures. The forward-looking way is based on a liquidity gap report, where the consideration of the counterbalancing capacity enables to gain an insight into the real liquidity needs. The measurement of both, the portfolio-value in the respective time bucket and liquidity costs, is possible. Applying the expected shortfall can easily be included into the calculation. The results show that by using historical simulation, if no sufficient data are available, expected shortfall delivers an approximate value. Still, it can serve as an indicator of insurance against extreme events. The present approach combines a scenario-based view to a possible distress with a quantitative risk measurement. Therewith, it contributes to the bank’s wide stress testing as required by the regulatory authorities.

The components of the bid‐ask spread: Evidence from the corn futures market

AbstractThis article examines whether USDA announcements and commodity index fund rolling activity have an impact on liquidity costs, measured by the bid‐ask spread. Using Huang and Stoll's (1997) model of liquidity costs, we estimate whether changes to liquidity costs are driven by its adverse selection, inventory, or order processing components. Commodity index fund roll activity reduces the asymmetric information cost component of liquidity cost due to an increased proportion of noninformation‐based trading, but the inventory cost component increases as (mostly long only) commodity index funds sell their nearby positions and buy the first deferred contract—raising liquidity providers’ risk of building a position. The sum of these two effects is that liquidity costs remain low during index fund roll periods, averaging one “tick” (0.25 cents). On USDA report release days, we find that informed traders raise the asymmetric information component of liquidity costs in the first hour after release, but the inventory cost component is reduced due to the increase in volume. Similar to index fund roll activity, liquidity costs on USDA report release days remain low, averaging one “tick”. Our findings that liquidity costs are minimally changed during USDA report releases and commodity index fund roll periods is consistent with other recent research on liquidity costs, but we show that what drives liquidity costs differs substantially depending on the circumstances surrounding daily trading.

Do ETFs Reduce Transaction Costs?

This paper investigates the impact of exchange-traded funds (ETFs) on the liquidity of their underlying stockholdings. Using a difference-in-differences methodology for large changes in the index weights of stocks in the S&P 500 and NASDAQ 100 indexes, we find that increases in ETF ownership are associated with increases in commonly used measures of liquidity. Stocks with high ETF ownership have higher price resilience and lower adverse selection costs. However, ETFs are linked to higher liquidation costs during the 2011 U.S. debt-ceiling crisis, suggesting that stocks with high ETF ownership may experience impaired liquidity during major market stress events.

Biased Decision-Making and Liquidity Buffer in Commercial Banking

Few derived versions based on the classic bank run model have taken into account the framing effect of general lenders. The purpose of this study is to revisit the issue and discuss a model of bank run equilibrium combined with biased risk preference, which is applied to analyze how portfolio allocation and liquidity buffer in commercial banks are affected by liquidation cost and the reference point. The results suggest the condition on which the liquidity buffer of a particular bank should provide. Liquidation cost is positively correlated with the lower bound of liquidity buffer. The effect of the reference point on liquidity buffer partially depends on the slope of yield curve term structure. Higher reference point could typically cause a lower portion of long-term investment.

Dimethyl Sulfoxide Assisted Ionic Liquid Pretreatment of Switchgrass for Isoprenol Production

The production cost and viscosity of certain ionic liquids (ILs) are among the major factors preventing the establishment of economically viable IL-based biomass pretreatment technologies. Recently, mixtures of an IL with an organic solvent have been proposed for cellulose processing and biomass pretreatment. Dimethyl sulfoxide (DMSO) is an inexpensive organic solvent that is industrially produced from lignin, a byproduct of the pulping process. We carry out a mechanistic study of DMSO-assisted IL pretreatment of switchgrass. The physical structures of biomass samples are studied by X-ray diffraction (XRD), N2 adsorption analysis, and small angle neutron scattering (SANS). Both dry and aqueous suspensions of biomass samples are measured by SANS which provides unique information on biomass pretreatment. A mixture of 42 wt % [C2C1Im][OAc] and 58 wt % DMSO is proposed as the optimal pretreatment solution, and the recycling and reuse of the mixture of solvents are also studied. The fermentability of the hydrolysates generated after pretreatment is evaluated using an E. coli strain engineered to produce isoprenol. This study suggests an avenue for developing more efficient and cost-effective IL-based processes for the production of lignocellulosic biofuels and bioproducts.

Banking panics and output dynamics

This paper develops a dynamic general equilibrium model with an essential role for an illiquid banking system to investigate output dynamics in the event of a banking crisis. In particular, it considers the ex-post efficient policy response to a banking crisis as part of the dynamic equilibrium analysis. It is shown that the trajectory of real output following a panic episode crucially depends on the cost of converting long-term assets into liquid funds. For small values of the liquidation cost, the recession associated with a banking panic is protracted as a result of the premature liquidation of a large fraction of productive banking assets to respond to a panic. For intermediate values, the recession is more severe but short-lived. For relatively large values, the contemporaneous decline in real output in the event of a panic is substantial but followed by a vigorous rebound in real activity above the long-run level.

Investigation and optimization of the recovery of coal fines using oil agglomeration process: Use of waste oils from different sectors

ABSTRACTThe high cost of the bridging liquid subdues the implementation and commercialization of oil agglomeration process. To overcome this problem, waste oils from different sectors were used in this present study. The performance of the process was assessed based on the responses like ash rejection and organic matter recovery. The aim of the present study was to investigate the usage of waste oils from different sectors and to optimize and analyze the behavioral pattern showcased by different variables (pulp density, oil dosage, agglomeration time and oil type) using response surface methodology (Box-Behnken design). Experimental investigation shows that the optimum pulp density, oil dosage, agglomeration time and oil type condition obtained as 3%, 15%, 15 min and waste engine oil, respectively. At optimum condition, the % ash rejection and % organic matter recovery obtained as 63.94% and 81.8%, respectively.

Wealth Inequality: An Informational Perspective

I examine how differences in the ability to identify profitable investment opportunities contribute to wealth inequality. I analyze a model of financial markets with investors heterogeneously informed about future returns. The unconditional wealth share distribution features a thick right-tail populated by the best-informed investors. Wealth inequality increases with the cost of information acquisition and market liquidity. It is non-monotone in the precision of public information and the size of investments delegated to the best-informed investors. I provide bounds for the speed of wealth dynamics. Using data on US households' beliefs, the model can explain the recent dynamics in wealth inequality.

Swing Pricing for Mutual Funds: Breaking the Feedback Loop between Fire Sales and Fund Redemptions

We develop a model of the feedback between mutual fund outflows and asset illiquidity. Following a market shock, alert investors anticipate the impact on a fund's net asset value (NAV) of other investors' redemptions and exit first at favorable prices. This first-mover advantage may lead to fund failure through a cycle of falling prices and increasing redemptions. Our analysis shows that (i) the first-mover advantage introduces a nonlinear dependence between a market shock and the aggregate impact of redemptions on the fund's NAV; (ii) as a consequence, there is a critical magnitude of the shock beyond which redemptions bring down the fund; (iii) properly designed swing pricing transfers liquidation costs from the fund to redeeming investors and, by removing the nonlinearity stemming from the first-mover advantage, it reduces these costs and prevents fund failure. Achieving these objectives requires a larger swing factor at larger levels of outflows. The swing factor for one fund may also depend on policies followed by other funds.

我国上市公司定向增发折价率影响因素的研究

本文采用主成分分析法，对选取的众多影响定向增发折价率的变量进行提取分类，以期确定这些主成分对定向增发折价率的影响程度，本文的主要研究结论如下：1) 在影响定向增发折价率的诸多因素中，信息不对称因素对其影响最大，且与其呈正相关关系；2) 市场行情影响程度次之，且与其呈正相关关系；3) 发行对象、大股东认购比例以及大股东认购比例与原持股比例的差额这三个代表利益输送因素的指标均与折价率存在正相关关系，从而佐证了利益输送假说。4) 代表流动性约束成本因素的两个指标，个股波动率和个股系统性风险均与折价率呈正相关关系，即个股波动率越大，个股系统性风险越高，从而流动性约束成本越高，折价率越高。这在一定程度上验证了流动性成本假说。5) 公司内在价值因素与定向增发折价率并不存在显著的相关关系，这一结论与理论分析及前人研究结果存在出入。 In this paper, we use principal component analysis to extract and classify many variables that af-fect the discount rate of private placement, in order to determine the extent to which these prin-cipal components affect the discount rate of private placement. The main conclusions of this paper are as follows: 1) Among the many factors affecting the rate of private placement discount, information asymmetry factors have the greatest impact on it and have a positive correlation with it. 2) Market conditions are the second largest factor and have a positive correlation with it. 3) The object of distribution, the subscription ratio of major shareholder and the difference between the subscription ratio of the major shareholder and the original shareholding ratio, all of these have positive correlations with the discount rate, and then verify the hypothesis of benefit transfer. 4) The volatility of individual stocks and the systematic risk of individual stocks which represent the cost constraint of liquidity constraints, are all positively correlated with the discount rate. In other words the larger the volatility of individual stocks, the higher the systemic risk of individual stocks, and the more liquidity constraint costs high, the higher the discount rate, and then verifies the liquidity cost hypothesis to a certain extent. 5) There is no significant correlation between the company intrinsic value and the private placement discount rate. This conclusion is different from the theoretical analysis and the predecessor research results.

Going Mobile, Investor Behavior, and Financial Fragility

This study investigates how trading technology affects retail investor behavior and mutual fund fragility using proprietary individual-level fund trading data. I exploit a natural experiment, the release of a popular trading application by a leading investment adviser in China. My difference-in-difference analysis shows going mobile raises investor attention and trading volume through aggravating investors' over-confidence and self-control problem. The app significantly boosts flow volatility, and makes investor flow more sensitive to short-term fund return and market sentiment. As a result, going mobile depresses fund performance by heightening indirect liquidity costs. The funds more exposed to the shock see a greater decline in abnormal return, explained by large fund flows through the trading app. Lastly, I combine Instrumental Variable method and a spatial discontinuity setting to strengthen causal inference. Overall, the paper shows going mobile intensifies financial fragility and dampens mutual fund performance by amplifying investors' cognitive biases.

Mean-variance model for portfolio optimization with background risk based on uncertainty theory

The aim of this paper is to develop a mean-variance model for portfolio optimization considering the background risk, liquidity and transaction cost based on uncertainty theory. In portfolio selection problem, returns of securities and assets liquidity are assumed as uncertain variables because of incidents or lacking of historical data, which are common in economic and social environment. We provide crisp forms of the model and a hybrid intelligent algorithm to solve it. Under a mean-variance framework, we analyze the portfolio frontier characteristic considering independently additive background risk. In addition, we discuss some effects of background risk and liquidity constraint on the portfolio selection. Finally, we demonstrate the proposed models by numerical simulations.