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A practical approach to constructing price-based funding liquidity factors

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  • Bouwman, Kees
  • Buis, Boyd
  • Pieterse-Bloem, Mary
  • Tham, Wing Wah

Abstract

The paper proposes a computationally convenient and parsimonious approach for creating a funding liquidity factor, building on work that relates the lack of funding of financial institutions to their ability to exploit arbitrage opportunities. Fontaine and Garcia (2012) propose a price-based funding liquidity factor from mispricing of bonds of similar characteristics but different ages. However, their arbitrage-free Nelson–Siegel framework requires the use of a non-linear Kalman filter, which is computationally intensive in practice. The novelty of this paper is to suggest an easier method for constructing an alternative liquidity factor that retains much of the same properties. Our proposed method for constructing this proxy liquidity factor relaxes the arbitrage-free assumption in the specification of the term structure model and bases it on a simple and flexible term structure specification. We demonstrate that this parsimonious liquidity factor fits the data well. The constructed factor is highly correlated with the Fontaine and Garcia (2012) liquidity factor and other funding liquidity measures, such as a liquidity factor by Hu et al. (2012), the TED-spread and the CP-spread.

Suggested Citation

  • Bouwman, Kees & Buis, Boyd & Pieterse-Bloem, Mary & Tham, Wing Wah, 2015. "A practical approach to constructing price-based funding liquidity factors," International Review of Economics & Finance, Elsevier, vol. 40(C), pages 90-97.
    • Handle: RePEc:eee:reveco:v:40:y:2015:i:c:p:90-97
    DOI: 10.1016/j.iref.2015.02.007
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    Cited by:

    1. Hammoudeh, Shawkat & McAleer, Michael, 2015. "Advances in financial risk management and economic policy uncertainty: An overview," International Review of Economics & Finance, Elsevier, vol. 40(C), pages 1-7.
    2. Marta Gómez-Puig & Mary Pieterse-Bloem & Simón Sosvilla-Rivero, 2022. ""Dynamic connectedness between credit and liquidity risks in EMU sovereign debt markets"," IREA Working Papers 202217, University of Barcelona, Research Institute of Applied Economics, revised Oct 2022.
    3. Buis, Boyd & Pieterse-Bloem, Mary & Verschoor, Willem F.C. & Zwinkels, Remco C.J., 2020. "Expected issuance fees and market liquidity," Journal of Financial Markets, Elsevier, vol. 48(C).

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    More about this item

    Keywords

    Funding liquidity; Flight-to-quality; Affine term structure models; Liquidity premium;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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