The LIX : a model-independent liquidity index
Faculty of Sciences. Mathematics and Computer Science
Journal of banking and finance. - Amsterdam
, p. 214-231
University of Antwerp
This paper provides a new model-free indicator of liquidity, the so-called LIX index. The computation of the LIX index combines the conic finance theory, which recognizes the two- price economy and is built upon the concept of indices of acceptability of Cherny & Madan (2010), with the option payoff spanning formula of Breeden & Litzenberger (1978). Matching the conic finance bid and ask prices of the stock with those observed in the market allows us to derive a model-free and unit-less indicator of spot liquidity. Just as the VIX and the SKEW index quantify the volatility and the tail risk perceived by todays investors, the resulting LIX index measures, in a similar market-implied fashion, the liquidity risk. The maximum likelihood estimation of popular mean-reverting processes applied to model-free liquidity time series indicates that spot liquidity tends to dry up during distress periods whereas a global drying-up of liquidity could not be detected during turmoil periods in the option market.