Title
Implied liquidity : model sensitivity Implied liquidity : model sensitivity
Author
Faculty/Department
Faculty of Sciences. Mathematics and Computer Science
Publication type
article
Publication
Amsterdam ,
Subject
Economics
Mathematics
Source (journal)
Journal of empirical finance. - Amsterdam
Volume/pages
23(2013) , p. 48-67
ISSN
0927-5398
ISI
000324083600004
Carrier
E
Target language
English (eng)
Full text (Publishers DOI)
Abstract
The concept of implied liquidity originates from the conic finance theory and more precisely from the law of two prices where market participants buy from the market at the ask price and sell to the market at the lower bid price. The implied liquidity λ of any financial instrument is determined such that both model prices fit as well as possible the bid and ask market quotes. It reflects the liquidity of the financial instrument: the lower the λ, the higher the liquidity. The aim of this paper is to study the evolution of the implied liquidity pre- and post-crisis under a wide range of models and to study implied liquidity time series which could give an insight for future stochastic liquidity modeling. In particular, we perform a maximum likelihood estimation of the CIR, Vasicek and CEV mean-reverting processes applied to liquidity and volatility time series. The results show that implied liquidity is far less persistent than implied volatility as the liquidity process reverts much faster to its long-run mean. Moreover, a comparison of the parameter estimates between the pre- and post-credit crisis periods indicates that liquidity tends to decrease and increase for long and short term options, respectively, during troubled periods.
E-info
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