Commonality in Liquidity

by Tarun Chordia of Vanderbilt University,
Richard Roll of the University of California, Los Angeles, and
Avanidhar Subrahmanyam of the University of California, Los Angeles

April 2000

Abstract: Traditionally and understandably, the microscope of market microstructure has focused on attributes of single assets. Little theoretical attention and virtually no empirical work has been devoted to common determinants of liquidity nor to their empirical manifestation, correlated movements in liquidity. But a wider-angle lens exposes an imposing image of commonality. Quoted spreads, quoted depth, and effective spreads co-move with market- and industry-wide liquidity. After controlling for well known individual liquidity determinants, such as volatility, volume, and price, common influences remain significant and material. Recognizing the existence of commonality is a key to uncovering some suggestive evidence that inventory risks and asymmetric information both affect intertemporal changes in liquidity.

JEL Classification: G23, D82.

Keywords: Liquidity, Trading costs, Co-movement, Microstructure.

Published in: Journal of Financial Economics, Vol. 56, No. 1, (April 2000), pp. 3-28.

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