A Model of Stochastic Liquidity

Masahiro Watanabe

Yale School of Management Working Papers from Yale School of Management

Abstract: This paper proposes a dynamic multi-security model in which liquidity reflects stochastic variation, persistence, and commonality of underlying information variance. Illiquidity, price-change variance, and trading volume all increase in the size of information. Using high frequency data, I perform structural estimation of the model by Bayesian Markov-Chain Monte-Carlo simulation, with the conditional volatility of underlying information modeled as stochastic volatility or realized volatility controlling for microstructure noise. I find that a Dow stock's liquidity decreases in the size of information about not only itself but also about other Dow stocks, demonstrating a significant cross-sectional effect of information on liquidity.

Keywords: Kyle model; liquidity; stochastic and realized volatility; Bayesian Markov-Chain Monte-Carlo (MCMC); GARCH; trading volume (search for similar items in EconPapers)
Date: 2003-06-01
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Persistent link: https://EconPapers.repec.org/RePEc:ysm:wpaper:ysm385

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