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3K visualizzazioni40 pagineOverview presentation on market liquidity and market liquidity risk by Sebastian Stange and Prof. Christoph Kaserer. Comments are highly appreciated.

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Overview presentation on market liquidity and market liquidity risk by Sebastian Stange and Prof. Christoph Kaserer. Comments are highly appreciated.

Attribution Non-Commercial (BY-NC)

100%(20)Il 100% ha trovato utile questo documento (20 voti)

3K visualizzazioni40 pagineOverview presentation on market liquidity and market liquidity risk by Sebastian Stange and Prof. Christoph Kaserer. Comments are highly appreciated.

Attribution Non-Commercial (BY-NC)

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An Overview

Chair of Financial Management and Capital Markets

Technische Universität München

Arcisstr. 21

D-80290 München

Tel.: +49 89 / 289 - 25485

Mail: Sebastian.Stange@wi.tum.de

URL: www.ifm.wi.tum.de

Presentation aims to convey state of research on market liquidity

Goals of this presentation

• Practitioners

• Quick introduction to important

aspects and developments

• Students

• Summary of current state of research for

• Researchers

• Starting point for further research

• Those interested

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 2

This presentation presents an overview on market liquidity

Agenda

• Introduction

• Market liquidity

– Definition

– Characteristics

– Measurement

– Empirical facts

• Market liquidity risk

– Introduction

– Models

• Summary and open research questions

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 3

Introduction

Press clippings

"Credit crisis puts heat on liquidity Liquidity always a hot topic – especially in

Financial market liquidity can take months to build but just crises

seconds to evaporate [...] Credit traders have received a • Liquidity always scarce when needed most

painful reminder of [...] strangled trading liquidity"

Financial Times, 30.07.2007

Institutional investors engage in illiquid

'Panicked Traders Take VW Shares on a Wild Ride - strategies

stock soared to as high as 1,005 euros a share ... after last • Sometimes large, concentrated position to

week at 210 euros.... short sellers were forced to act"

exploit market inefficiencies

NY Times, 28.08.2008 • Returns due to liquidity risk compensation?

'Some less liquid strategies which also provided genuine

portfolio diversification [...] have romped past the S&P Trading strategies rely on tradability of assets

500' • Hedging often requires frequent trading

Michael Goldman, Global Investor, 04/2007

"Unless you include liquidity in your models, which some Risk management still needs to account for

small funds don't, then the model may not always work." illiquidity

Euromoney, June 2007 • Often neglected

'[Quantitative strategies] rely on their ability to trade with • Strong recent pressure from regulators

high frequency […] What if the model is built to sell a

company at 20, but there is no buyer?'

Euromoney, June 2007

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 4

Introduction

literature structure

Supply-demand

curve Transaction cost

literature

Liquidity

Anomaly

explanation Limits to

arbitrage

Factor in

asset pricing Risk

Asset

management

management

= Causes

= Effect

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 5

Introduction

Delimitation of topic area

• Liquidity of assets only • Perspective of a firm

– "Marketability" (solvency)

• Corporate finance view

– "Ease of trading an

asset"

• Perspective of an investor

• Capital market view

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 6

This presentation presents an overview on market liquidity

Agenda

• Introduction

• Market liquidity

– Definition

– Characteristics

– Measurement

– Empirical facts

• Market liquidity risk

– Introduction

– Models

• Summary and open research questions

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 7

Market liquidity – Definition

Liquidity cost has three components

• Relative to fair value

Lt(q) • Fair value often set at mid-price, i.e. mid-point of bid-ask-spread

=

Direct trading costs • Includes exchange fees, commissions, taxes

• Deterministic

D(q) • Small for institutional investors

+

Price impact costs • Difference between transaction price and mid-price

PIt(q) • Depends on order size q and point of time

+

Delay costs

• Includes search cost, cost due to add. risk during delay

Dt(q)

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 8

Market liquidity – Definition Backup

• "Ease of trading an asset" Longstaff • Very general

• "Marketability" (1995) • Cost perspective more

specific

around in a short time" • No unifying perspective

• Depth = "size of an order flow innovation

required to change prices a given amount"

• Resiliency = "speed with which prices

recover from a random, uninformative

shock"

submission and settlement • No unifying perspective

• Time

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 9

Market liquidity – Characteristics

Asset type, order size and horizon are major liquidity determinants

exogenous

asset – Value certainty

endogenous

Order • Reasons

size • Heterogeneous opinion

• Delay probability

• Capital restrictions

endogenous

Liquidation • Costs relative to return are small when held over long period

horizon • Costs are zero for assets held to maturity

• Hence, liquidity is a characteristic of the trading process

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 10

Market liquidity – Characteristics

Liquidity degrees and categories

liquidity costs

Relative

Degree of

illiquidity

liquid illiquid

trading trading trading trading

Category

• All order sizes of the • Order sizes can be • Asset are traded from • No order size of the

asset can be traded at traded at a cost time to time asset is traded

zero costs • Price impact cost • Zero trading days occur • Prohibitive Liquidity costs

important • Delay cost important

• Cash • Limit order book markets • OTC markets of more • Rare art, CDOs?

Ex.

• None, no liquidity • Precise liquidity cost • Liquidity cost and delay • Intrinsic value

issue

Main

price non-observable

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 11

Market liquidity – Characteristics

Liquidity costs increase with quantity transacted

Price

ask price

Bid-ask- mid price

spread area = absolute liquidity costs

bid price

Market depth

Quantity

Quote depth / Size of next-best transacted

Size of best limit orders bid order

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 12

Market liquidity – Characteristics

– Delaying parts of the transaction reduces order size and hence liquidity costs

– But, uncertain future price and liquidity costs, i.e. delay costs, for delayed parts

of the position

– Optimal strategy balances liquidity cost saving against increased delay costs

– Maximize expected liquidation proceeds

– Maximize expected liquidation proceeds with penalty for potential shortfall

(proceed variance)

• Corresponds to maximizing proceeds VaR

– No optimization strategy is applied

– Proceeds are certain

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 13

Market liquidity – Measurement

Multitude of direct measures and proxies available

• Fees

• Quoted bid-ask-spread (Amihud, Mendelson, JFinEco 86)

• Traded bid-ask-spread

• Effective bid-ask-spread (Roll, JoF 84)

Direct • Relation between price change and order flow (Brennan, Subrahmanyam,

measures JFinEco, 96)

• Price response to turnover (Amihud, JFinMar 02)

• Volume related reversal (Pastor, Stambaugh, JPolEco 03)

• Weighted spread by order size (Irvine et. al., working paper 00)

• Depth

• Volume

Indirect • Number of transactions

measures • Turnover rate (Datar et al, JFinMar 98)(1)

• Proportion of zero-trading days (Bekaert et al., WP, 03)

• Turnover-adjusted zero trading days (Liu, JFinEco 06)

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 14

Market liquidity – Measurement

• Discount vs. achievable price in limit order • Direct trading costs are zero

book – Ok for institutional investors

• Equals area between limit order curves • Asset position continuously tradable

• Ok for developed markets and positions

• Generalization of bid-ask-spread to rest of the

smaller than market depth

limit order book

• Immediate liquidation

• Precise price impact measure

• Ok, if optimal trading strategies

L(q)= WS(q) / 2

neglectable

• Weighted spread data available

• Ok in many electronic limit order book

markets

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 15

Market liquidity – Measurement

Example: Weighted spread for German stocks (I/III)

500

454

SDAX

400

331

TECDAX

300

214

MDAX

200

146

DAX

110

100

52

27

15

0

vol 10 vol 25 vol 50 vol 75 vol 100 vol 150 vol 250 vol 500 vol 750 vol 1000 vol 2000 vol 3000 vol 4000 vol 5000

Volume in k €

Note: Sample = daily data for 160 stocks in four major German stock indices over 5.5 years (II/02-1/08) (not to scale)

Source: Stange, Kaserer (2008a)

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 16

Market liquidity – Measurement

Example: Average weighted spread for German stock indices (II/III)

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 17

Market liquidity – Measurement

Example: Weighted spread for German stocks by selected order size, indexed (II/III)

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 18

Market liquidity – Empirical facts Backup

– Price impact is concave (Hasbrouck 1991, Stange/Kaserer 2008)

– Over 50% of total trading cost from price impact and delay (Kritzman, Myrgren

and Page 2006)

• There is strong variation over time

– Flight-to-liquidity asymmetry: Liquid assets become more liquid and less liquid

less liquid in crises (Acharya and Pedersen (2005), Longstaff (2004))

• Liquidity measures determine asset prices

– Market liquidity esp. important for pricing – no full diversification possible

(Acharya and Pedersen (2005) for stock market; Goyenko (2005) for

integration between stock and bond market)

– Further sources: Amihud and Mendelson (1986); Datar, Y. Naik, and Radcliffe

(1998); Amihud (2002); Pastor and Stambaugh (2003); Acharya and Pedersen

(2005); Ang, Chen, and Xing (2006), Keene and Peterson (2007) and others

• There is strong liquidity commonality

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 19

This presentation presents an overview on market liquidity

Agenda

• Introduction

• Market liquidity

– Definition

– Characteristics

– Measurement

– Empirical facts

• Market liquidity risk

– Introduction

– Models

• Summary and open research questions

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 20

Market liquidity risk – Introduction

• Value-at-Risk (VaR) measures worst loss in • Assumes that position can be liquidated

α% of the cases over a specific forecast without significant cost

horizon h – Bid-ask-spread neglected

– (1-α) is confidence level – Price impact of position size neglected

– Loss is generally the forecasted loss in – Market conditions and liquidation horizon

market prices neglected

Future market price distribution at horizon h

within any given horizon

– No delay costs

estimates used, but only rough proxy for true

liquidity risk

– Flat lengthening of horizon

– Artificial increase of volatilities

– Flat liquidity cost deduction ("hair cut") by

asset class

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 21

Market liquidity risk – Introduction

Several price definitions can be used

• Middle of bid-ask-spread • Ex-post achieved transaction price

Bid- / ask-price • Can be inside bid-ask-spread if market

• Usually quoted by market maker maker transacts within spread

– But sometimes best limit order prices • Usually outside bid-ask-spreads for

if no market maker coverage larger order sizes

• Ex-ante achievable transaction price for

buy/sell-transaction

– But for small volume (=bid-ask-

depth) only

Achievable price in limit order book

• Ex-ante price when transacting larger

orders as market order against limit

order book

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 22

Market liquidity risk – Introduction

– Usual assumption that liquidity cost can be neglected if horizon is long enough

– Partially accounted for via asset-class-specific "hair cuts"

• Expert estimates of liquidity cost deduction

• However, liquidity costs are substantial and strongly vary between securities

– 25-30 % underestimation of total risk in emerging market currencies (Bangia et

al. 1999)

– Bid-ask-spread component over 50 % of total risk for illiquid stocks (Le Saout

2002)

– 30 % liquidity contribution to intraday risk in small price stocks (Lai 2007)

– Up to 25-30 % liquidity impact on price risk at 10-day horizons (Stange/Kaserer

2008a)

• More than doubles at daily horizons

• Large variance between stocks and position sizes

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 23

Market liquidity risk – Models

Model overview

1. Bangia et al. (1999): Add-on model with

• Available data bid-ask-spread

2. Ernst et al. (2008): Modified add-on model

• Type of liquidity measurement with bid-ask-spread

3. Berkowitz (2000): Transaction regression

• Assumptions on the structure of liquidity model

4. Cosandey (2001): Volume based price

impact

5. Angelidis, Benos (2006): Structurally

implied spread

6. Francois-Heude, Wynendaele (2001): Limit

order model

7. Giot, Gramming (2008): T-distributed net

return model with weighted spread

8. Stange, Kaserer (2008): Empirical net-

return model with weighted spread

Note: Untraceable models excluded from overview.

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 24

Market liquidity risk – Models

1 Bangia et al. (1999): Add-on model with bid-ask-spread

• Simple add-on, hence quickly implementable

ask-spread

• However, liquidity costs can quickly rise

beyond bid-ask-spread when trading

positions larger than bid-ask-depth

• Tends to underestimate risk

Liquidity Risk Measurement – Assumes perfect liquidity – price correlation

• Worst spread and worst price occur

• Worst spread added as cost to worst price

simultaneously

• Tends to overestimate risk

– Logically inconsistent because worst spread

deducted from current, not worst prices

• Easily correctable

• Empirical distribution ( ) used for worst • Tends to overestimate risk

spread estimation – Historical spread distribution might poorly

• Normal distribution used for price risk

proxy for future distribution

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 25

Market liquidity risk – Models

2 Ernst et al. (2008): Modified add-on model with bid-ask-spread (I/II)

• Other liquidity measures can be used accounting for non-normality via Cornish-

analogously Fisher approximation

• Provides empirically more precise results than

Bangia et al. (1999)

• See Ernst et al. (2008)

• Can be applied to other liquidity cost

measures as well

• See Ernst et al. (2009)

Liquidity Risk Measurement

– Skewness and kurtosis need to be

• Worst cost added to worst price

additionally estimated

which take skewness ( ) and excess-kurtosis

( ) into account

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 26

Market liquidity risk – Models

2 Ernst et al. (2008): Modified add-on model with bid-ask-spread (II/II)

Note: "Risk correctly estimated" is determined via standard Kupiec (1995)-statistic; Sample = 160 stocks in four major German stock indices over 5.5 years

Source: Ernst, Stange, Kaserer (2008)

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 27

Market liquidity risk – Models

3 Berkowitz (2000): Transaction regression model

• Abs. liquidity cost per share ( ) derived from • Integrates price impact of order size

linear regression of transaction prices when

controlling for other risk factor changes (x) – High data requirements

– Liquidity measure highly approximate

• Measurement very noisy

– Assumption of zero price-liquidity correlation

• Independence between price risk and

liquidity impact

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 28

Market liquidity risk – Models

4 Cosandey (2001): Price impact derived from volume

• Accounts for price impact of order size via

simple theoretical assumption

• Assumes that position increases number of with traded share volume)

shares but total traded value – Price impact linear to relative traded shares

• Concavity of price impact function

neglected

Liquidity Risk Measurement

of traded shares

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 29

Market liquidity risk – Models

5 Angelidis, Benos (2006): Structurally-implied spread

• Spread model estimated from intraday data • Partially accounts for price impact of order

• Model derived from theoretical ideas on size via increased volume percentile

liquidity drivers

• Traded shares N, degree of info assym. – Unclear if structural model is correct

theta, price elasticity to volume kappa, – Complicated estimation of parameters in

liquidity fixed cost Phi intraday data required

– Possible overestimation because liquidity-

return correlation assumed perfect

• Calculated with top-percentile of volume

• Assumes that individual position size

dissipates in market

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 30

Market liquidity risk – Models

6 Francois-Heude and Wynendaele (2001): Price impact from best limit orders

• Price impact curve estimated from best five • Accounts for price impact of order size

limit orders • Price impact more precise because directly

• Available from Paris Bourse measured in limit order book

• Extrapolated for larger sizes

– Only applicable in electronic limit order book

markets

– Time variation of liquidity neglected

– Assumes perfect correlation between liquidity

and price

Liquidity Risk Measurement – Five best limit orders need to be available

– Intraday only

• Normal price risk adjusted for average price – Liquidity cost only extrapolated for medium to

impact large order sizes

• Correction term for difference between – Somewhat arbitrary spread adjustment

average and stock-specific price impact – Provides empirically imprecise results than

other models using limit order data

• See Ernst et al. (2008)

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 31

Market liquidity risk – Models

7 Giot, Gramming (2005): T-distributed net-return model with weighted spread

• Size-specific liquidity cost extracted as • Accounts for price impact of order size in very

weighted spread from limit order book precise way

• Correctly accounts for liquidity-return

correlation

• at(n) and bt(n) are weighted ask and bid- markets

prices for trading n = q/Pmid shares – Intraday data required if lower frequencies not

provided by exchange

Liquidity Risk Measurement – Possible overestimation if instant liquidation

assumption is suboptimal

• T-distribution percentile of historical net return – Possible distortion through assumption of t-

distribution distributed net-returns

• Net return is mid-price return net of

weighted spread liquidity costs

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 32

Market liquidity risk – Models

Precise empirical price impact measurement with limit order book data

8 Stange and Kaserer (2008): Price impact measured with weighted spread

• Size-specific liquidity cost extracted as • Accounts for price impact of order size in very

weighted spread from limit order book precise way

• Correctly accounts for liquidity-return

correlation

• at(n) and bt(n) are weighted ask and bid- markets

prices for trading n = q/Pmid shares – Intraday data required if lower frequencies not

provided by exchange

Liquidity Risk Measurement – Possible overestimation if instant liquidation

assumption is suboptimal

• Empirical percentile of historical net return

distribution

• Net return is mid-price return net of

weighted spread liquidity costs

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 33

Market liquidity risk – Models

Model overview

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 34

Market liquidity risk – Models

Model performance

Note: "Acceptance rate" is fraction of stocks where Kupiec (1995)-statistic could not reject deviation between realized and predicted loss frequency; ; Sample

= 160 stocks in four major German stock indices over 5.5 years

Source: Ernst, Stange, Kaserer (2009)

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 35

This presentation presents an overview on market liquidity

Agenda

• Market liquidity

– Definition

– Characteristics

– Measurement

– Empirical facts

• Market liquidity risk

– Introduction

– Models

• Summary and open research questions

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 36

Summary Market Liquidity

• Components: Direct trading costs, price impact costs, delay costs

• Determinants: type of asset, order size, liquidation horizon

• Continuous liquidity degrees – different treatment required

• Optimal trading strategies developed to minimize sum of cost components

– Balance increased delay cost against reduced price impact

– Less relevant for risk management

• Several liquidity measures available

– Direct liquidity measure promise increased precise liquidity measurement

• Market liquidity risk is substantial, but often neglected

• Models based on limit order data perform better in backtests

• Modified risk model (Ernst et al. 2008) consistently outperforms

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 37

Backup

1. Can the superiority of the model of Ernst et al. (2008) be improved via better moment estimation techniques?**

2. Estimation and validity of optimal trading strategies (OTS)*

– How can parameters of theoretical models with optimal trading strategies be estimated?

– In which situations are optimal trading strategies beneficial compared with instant liquidation - in normal times or also

in crises?

3. In which situations are liquidity costs efficient?

• How should arbitrage strategies be constructed?

• What drives the efficiency of markets?

4. Are total liquidation costs per stock an asset pricing factor?

– Total liquidation costs can be estimated via weighted spread times traded size distribution

5. Can the price impact curve be described via theoretical processes?

– Similar to interest rate curve

– Arbitrage conditions also apply if liquidity price are efficient

– Can be helpful when describing unobservable / hidden liquidity

6. Is it possible to construct liquidity options – in analogy to volatility options?

7. How high are liquidity cost / risk levels between different asset classes?

8. Can the stability of liquidity cost for relative order size be used in liquidity risk measurement?

– Liquidity costs are relatively constant for order size in relation to volume and market value in the cross section

(Stange, Kaserer 2008)

– Is this helpful in implementing an asset class, not asset specific liquidity risk approach?

9. How should liquidity risk be integrated into portfolios?

– What is the role of liquidity commonality in the covariance matrix?

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 38

Backup

Further references

• Bervas (2006) "Market Liquidity and its Incorporation Into Risk Management", Banque de France technical

report, http://www.gloriamundi.org

• Ernst, C., S. Stange. and C. Kaserer (2008a) "Accounting for Non-normality in Liquidity Risk", CEFS

working paper 2008 No. 14, www.cefs.de

• Ernst, C., S. Stange. and C. Kaserer (2008b) "Empirical evaluation of market liquidity risk models", CEFS

working paper 2009 No. 1, www.cefs.de

• Erzegovesi (2002) "VaR and Liquidity Risk. Impact on Market Behaviour and Measurement Issues", Alea

Technical Reports Nr. 14, http://eprints.biblio.unitn.it

• Jorion (2007) "Value at risk: the new benchmark for managing Financial risk", 2. Ed., McGraw-Hill, New

York

• Loebnitz (2006) "Market Liquidity Risk: Elusive no more - Defining and quantifying market liquidity risk",

diploma thesis, University of Twente, http://purl.org/utwente/e582

• Mahadevan, A. (2001) "Incorporating Liquidity Risk in VAR estimation", ICICI Working paper,

http://www.gloriamundi.org

• Stange, S. and C. Kaserer (2008a): "The Impact of Order Size on Stock Liquidity - A Representative

Study", CEFS working paper, www.cefs.de

• Stange, S. and C. Kaserer (2008b) "Why and How to Measure Liquidity Risk", CEFS working paper,

www.cefs.de

• Stange, S. and C. Kaserer (2009) "Market Liquidity Risk – An Overview", CEFS working paper,

www.cefs.de

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 39

Thank you for your attention!

Comments are warmly welcome.

Stange Kaserer

Sebastian Stange and Christoph Kaserer, Chair of Financial Management and Capital Markets 40

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