An Empirical Analysis of Stock and Bond Market Liquidity

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Chordia, Tarun; Sarkar, Asani; Subrahmanyam, Avanidhar

Working Paper

An empirical analysis of stock and bond market liquidity
Staff Report, Federal Reserve Bank of New York, No. 164 Provided in Cooperation with: Federal Reserve Bank of New York

Suggested Citation: Chordia, Tarun; Sarkar, Asani; Subrahmanyam, Avanidhar (2003) : An empirical analysis of stock and bond market liquidity, Staff Report, Federal Reserve Bank of New York, No. 164

This Version is available at: http://hdl.handle.net/10419/60642

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Leibniz-Informationszentrum Wirtschaft Leibniz Information Centre for Economics

An Empirical Analysis of Stock and Bond Market Liquidity Tarun Chordia, Asani Sarkar, and Avanidhar Subrahmanyam Federal Reserve Bank of New York Staff Reports, no. 164 March 2003 JEL classification: G10, G14, G23, E52

Abstract This paper explores liquidity movements in stock and Treasury bond markets over a period of more than 1800 trading days. Cross-market dynamics in liquidity are documented by estimating a vector autoregressive model for liquidity (that is, bid-ask spreads and depth), returns, volatility, and order flow in the stock and bond markets. We find that a shock to quoted spreads in one market affects the spreads in both markets, and that return volatility is an important driver of liquidity. Innovations to stock and bond market liquidity and volatility prove to be significantly correlated, suggesting that common factors drive liquidity and volatility in both markets. Monetary expansion increases equity market liquidity during periods of financial crises, and unexpected increases (decreases) in the federal funds rate lead to decreases (increases) in liquidity and increases (decreases) in stock and bond volatility. Finally, we find that flows to the stock and government bond sectors play an important role in forecasting stock and bond liquidity. The results establish a link between “macro” liquidity, or money flows, and “micro” or transactions liquidity.

______________________________ Chordia: Goizueta Business School, Emory University (e-mail: tarun_chordia@bus.emory.edu); Sarkar: Research and Market Analysis Group, Federal Reserve Bank of New York, New York, N.Y. 10045 (e-mail: asani.sarkar@ny.frb.org); Subrahmanyam: Anderson Graduate School of Management, University of California at Los Angeles (asubrahm@anderson.ucla.edu). The authors are grateful to an anonymous referee and Cam Harvey for providing insightful and constructive comments on an earlier draft. The authors also thank Michael Brennan, Arturo Estrella, Michael Fleming, Clifton Green, Joel Hasbrouck, Charlie Himmelberg, Eric Hughson, Charles Jones, Ken Kuttner, Stavros Peristiani, Raghu Rajan, René Stulz, Ross Valkanov, and seminar participants at the SFS/Kellogg conference on Investment in Imperfect Capital Markets for helpful comments and/or for encouraging us to explore these issues. The authors thank Michael Emmet for...
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