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Noise as Information for Illiquidity
Author(s) -
HU GRACE XING,
PAN JUN,
WANG JIANG
Publication year - 2013
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/jofi.12083
Subject(s) - market liquidity , liquidity crisis , arbitrage , liquidity risk , treasury , hedge fund , funding liquidity , monetary economics , bond , economics , noise (video) , accounting liquidity , financial economics , business , finance , computer science , image (mathematics) , archaeology , artificial intelligence , history
We propose a market‐wide liquidity measure by exploiting the connection between the amount of arbitrage capital in the market and observed “noise” in U.S. Treasury bonds—the shortage of arbitrage capital allows yields to deviate more freely from the curve, resulting in more noise in prices. Our noise measure captures episodes of liquidity crises of different origins across the financial market, providing information beyond existing liquidity proxies. Moreover, as a priced risk factor, it helps to explain cross‐sectional returns on hedge funds and currency carry trades, both known to be sensitive to the general liquidity conditions of the market.