Measuring liquidity commonality in financial markets

Chenlu Li, Baibing Li and Kai-Hong Tee

Quantitative Finance, 2020, vol. 20, issue 9, 1553-1566

Abstract: This paper contributes to the literature by developing a new methodology, termed the beta index, for measuring liquidity commonality in financial markets which is derived from the dynamics of liquidity co-movements. We show that computing the beta index is a straightforward process. In addition, not only is the proposed beta index more efficient in controlling for confounding factors and addressing the associated statistical inference issues, but it will also enhance the accuracy of estimation. We apply the beta index to track liquidity commonality in the foreign exchange markets over the study period and to identify important financial and economic events that caused liquidity commonality. We detect periods of high and low liquidity commonalities that would especially benefit active market traders who frequently rebalance portfolios and require knowledge of liquidity commonality as an important early signal and indication of diversification benefit.

Date: 2020
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DOI: 10.1080/14697688.2020.1744698

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