IDEAS home Printed from https://ideas.repec.org/p/chf/rpseri/rp1025.html
   My bibliography  Save this paper

Money and Liquidity in Financial Markets

Author

Listed:
  • Kjell G. NYBORG

    (University of Zurich, Swiss Finance Institute, NHH and CEPR)

  • Per OSTBERG

    (University of Zurich, Swiss Finance Institute and NHH)

Abstract

We argue that there is a connection between the interbank market for liquidity and the broader financial markets, which has its basis in demand for liquidity by banks. Tightness in the interbank market for liquidity leads banks to engage in what we term “liquidity pull-back,” which involves selling financial assets either by banks directly or by levered investors. Empirical tests support this hypothesis. While our data covers part of the recent crisis period, our results are not driven by the crisis. Our general point is that money matters in financial markets. Different financial assets have different degrees of moneyness (liquidity) and, as a result, there are systematic cross-sectional variations in trading activity as the price of liquidity, or the level of tightness, in the interbank market fluctuates.

Suggested Citation

  • Kjell G. NYBORG & Per OSTBERG, 2010. "Money and Liquidity in Financial Markets," Swiss Finance Institute Research Paper Series 10-25, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1025
    as

    Download full text from publisher

    File URL: http://ssrn.com/abstract=1625648
    Download Restriction: no
    File URL:
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Tarun Chordia & Richard Roll & Avanidhar Subrahmanyam, 2001. "Market Liquidity and Trading Activity," Journal of Finance, American Finance Association, vol. 56(2), pages 501-530, April.
    2. Harald Hau & Hélène Rey, 2004. "Can Portfolio Rebalancing Explain the Dynamics of Equity Returns, Equity Flows, and Exchange Rates?," American Economic Review, American Economic Association, vol. 94(2), pages 126-133, May.
    3. Fecht, Falko & Nyborg, Kjell G. & Rocholl, Jörg, 2008. "The price of liquidity: bank characteristics and market conditions," Discussion Paper Series 1: Economic Studies 2008,30, Deutsche Bundesbank.
    4. repec:bla:jfinan:v:43:y:1988:i:3:p:617-37 is not listed on IDEAS
    5. Gur Huberman & Dominika Halka, 2001. "Systematic Liquidity," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 24(2), pages 161-178, June.
    6. Acharya, Viral V. & Pedersen, Lasse Heje, 2005. "Asset pricing with liquidity risk," Journal of Financial Economics, Elsevier, vol. 77(2), pages 375-410, August.
    7. Milton Friedman, 1971. "A Theoretical Framework for Monetary Analysis," NBER Books, National Bureau of Economic Research, Inc, number frie71-1.
    8. Ray C. Fair, 2002. "Events That Shook the Market," The Journal of Business, University of Chicago Press, vol. 75(4), pages 713-732, October.
    9. Zivot, Eric & Andrews, Donald W K, 2002. "Further Evidence on the Great Crash, the Oil-Price Shock, and the Unit-Root Hypothesis," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(1), pages 25-44, January.
    10. Lo, Andrew W & MacKinlay, A Craig, 1990. "When Are Contrarian Profits Due to Stock Market Overreaction?," The Review of Financial Studies, Society for Financial Studies, vol. 3(2), pages 175-205.
    11. Pastor, Lubos & Stambaugh, Robert F., 2003. "Liquidity Risk and Expected Stock Returns," Journal of Political Economy, University of Chicago Press, vol. 111(3), pages 642-685, June.
    12. Amihud, Yakov & Mendelson, Haim, 1986. "Asset pricing and the bid-ask spread," Journal of Financial Economics, Elsevier, vol. 17(2), pages 223-249, December.
    13. Grossman, S.J. & Miller, M.H., 1988. "Liquidity And Market Structure," Papers 88, Princeton, Department of Economics - Financial Research Center.
    14. Chordia, Tarun & Roll, Richard & Subrahmanyam, Avanidhar, 2002. "Order imbalance, liquidity, and market returns," Journal of Financial Economics, Elsevier, vol. 65(1), pages 111-130, July.
    15. Michael J. Fleming & Eli M. Remolona, 1997. "What moves the bond market?," Economic Policy Review, Federal Reserve Bank of New York, vol. 3(Dec), pages 31-50.
    16. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 22(6), pages 2201-2238, June.
    17. Tarun Chordia & Asani Sarkar & Avanidhar Subrahmanyam, 2003. "An empirical analysis of stock and bond market liquidity," Staff Reports 164, Federal Reserve Bank of New York.
    18. Gorton, Gary & Metrick, Andrew, 2012. "Securitized banking and the run on repo," Journal of Financial Economics, Elsevier, vol. 104(3), pages 425-451.
    19. Monika Piazzesi, 2005. "Bond Yields and the Federal Reserve," Journal of Political Economy, University of Chicago Press, vol. 113(2), pages 311-344, April.
    20. Lee, Charles M C & Ready, Mark J, 1991. "Inferring Trade Direction from Intraday Data," Journal of Finance, American Finance Association, vol. 46(2), pages 733-746, June.
    21. Gorton, Gary & Metrick, Andrew, 2012. "Securitized banking and the run on repo," Journal of Financial Economics, Elsevier, vol. 104(3), pages 425-451.
    22. Lo, Andrew W & Wang, Jiang, 2000. "Trading Volume: Definitions, Data Analysis, and Implications of Portfolio Theory," The Review of Financial Studies, Society for Financial Studies, vol. 13(2), pages 257-300.
    23. Ang, Andrew & Gorovyy, Sergiy & van Inwegen, Gregory B., 2011. "Hedge fund leverage," Journal of Financial Economics, Elsevier, vol. 102(1), pages 102-126, October.
    24. Andrew Ang & Robert J. Hodrick & Yuhang Xing & Xiaoyan Zhang, 2006. "The Cross‐Section of Volatility and Expected Returns," Journal of Finance, American Finance Association, vol. 61(1), pages 259-299, February.
    25. Chordia, Tarun & Roll, Richard & Subrahmanyam, Avanidhar, 2000. "Commonality in liquidity," Journal of Financial Economics, Elsevier, vol. 56(1), pages 3-28, April.
    26. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 33(1), pages 125-132.
    27. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-636, May-June.
    28. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-1335, November.
    29. Goetzmann, William N. & Massa, Massimo, 2002. "Daily Momentum and Contrarian Behavior of Index Fund Investors," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 37(3), pages 375-389, September.
    30. George A. Akerlof, 1970. "The Market for "Lemons": Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 84(3), pages 488-500.
    31. Ulrich Bindseil & Kjell G. Nyborg & Ilya A. Strebulaev, 2009. "Repo Auctions and the Market for Liquidity," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(7), pages 1391-1421, October.
    32. Hasbrouck, Joel & Seppi, Duane J., 2001. "Common factors in prices, order flows, and liquidity," Journal of Financial Economics, Elsevier, vol. 59(3), pages 383-411, March.
    33. King, Mervyn A & Wadhwani, Sushil, 1990. "Transmission of Volatility between Stock Markets," The Review of Financial Studies, Society for Financial Studies, vol. 3(1), pages 5-33.
    34. Laurent E. Calvet & John Y. Campbell & Paolo Sodini, 2009. "Fight or Flight? Portfolio Rebalancing by Individual Investors," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 124(1), pages 301-348.
    35. Karpoff, Jonathan M., 1987. "The Relation between Price Changes and Trading Volume: A Survey," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(1), pages 109-126, March.
    36. Edelen, Roger M. & Warner, Jerold B., 2001. "Aggregate price effects of institutional trading: a study of mutual fund flow and market returns," Journal of Financial Economics, Elsevier, vol. 59(2), pages 195-220, February.
    37. Jeremy C. Stein & Anil K. Kashyap, 2000. "What Do a Million Observations on Banks Say about the Transmission of Monetary Policy?," American Economic Review, American Economic Association, vol. 90(3), pages 407-428, June.
    38. Boyer, Brian & Zheng, Lu, 2009. "Investor flows and stock market returns," Journal of Empirical Finance, Elsevier, vol. 16(1), pages 87-100, January.
    39. Chordia, Tarun & Subrahmanyam, Avanidhar, 2004. "Order imbalance and individual stock returns: Theory and evidence," Journal of Financial Economics, Elsevier, vol. 72(3), pages 485-518, June.
    40. Chordia, Tarun & Roll, Richard & Subrahmanyam, Avanidhar, 2008. "Liquidity and market efficiency," Journal of Financial Economics, Elsevier, vol. 87(2), pages 249-268, February.
    41. Myron S. Scholes, 2000. "Crisis and Risk Management," American Economic Review, American Economic Association, vol. 90(2), pages 17-21, May.
    42. David B. Brown & Bruce Ian Carlin & Miguel Sousa Lobo, 2010. "Optimal Portfolio Liquidation with Distress Risk," Management Science, INFORMS, vol. 56(11), pages 1997-2014, November.
    43. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
    44. Dwight M. Jaffee & Thomas Russell, 1976. "Imperfect Information, Uncertainty, and Credit Rationing," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 90(4), pages 651-666.
    45. repec:bla:jfinan:v:43:y:1988:i:3:p:701-17 is not listed on IDEAS
    46. Goyenko, Ruslan Y. & Holden, Craig W. & Trzcinka, Charles A., 2009. "Do liquidity measures measure liquidity?," Journal of Financial Economics, Elsevier, vol. 92(2), pages 153-181, May.
    47. Allen B. Atkins & Edward A. Dyl, 1997. "Market Structure And Reported Trading Volume: Nasdaq Versus The Nyse," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 20(3), pages 291-304, September.
    48. Huberman, Gur & Halka, Dominika, 2001. "Systematic Liquidity," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 24(2), pages 161-178, Summer.
    49. Tarun Chordia, 2005. "An Empirical Analysis of Stock and Bond Market Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 85-129.
    50. Chordia, Tarun & Sarkar, Asani & Subrahmanyam, Avanidhar, 2011. "Liquidity Dynamics and Cross-Autocorrelations," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 46(3), pages 709-736, June.
    51. Gallant, A Ronald & Rossi, Peter E & Tauchen, George, 1992. "Stock Prices and Volume," The Review of Financial Studies, Society for Financial Studies, vol. 5(2), pages 199-242.
    52. Ferson, Wayne E & Harvey, Campbell R, 1993. "The Risk and Predictability of International Equity Returns," The Review of Financial Studies, Society for Financial Studies, vol. 6(3), pages 527-566.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Chordia, Tarun & Sarkar, Asani & Subrahmanyam, Avanidhar, 2005. "The Joint Dynamics of Liquidity, Returns, and Volatility Across Small and Large Firms," University of California at Los Angeles, Anderson Graduate School of Management qt6z81z2wc, Anderson Graduate School of Management, UCLA.
    2. Vayanos, Dimitri & Wang, Jiang, 2013. "Market Liquidity—Theory and Empirical Evidence ," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1289-1361, Elsevier.
    3. Subrahmanyam, Avanidhar, 2009. "The implications of liquidity and order flows for neoclassical finance," Pacific-Basin Finance Journal, Elsevier, vol. 17(5), pages 527-532, November.
    4. Tarun Chordia & Asani Sarkar & Avanidhar Subrahmanyam, 2003. "An empirical analysis of stock and bond market liquidity," Staff Reports 164, Federal Reserve Bank of New York.
    5. Chordia, Tarun & Roll, Richard & Subrahmanyam, Avanidhar, 2008. "Liquidity and market efficiency," Journal of Financial Economics, Elsevier, vol. 87(2), pages 249-268, February.
    6. Nina Karnaukh & Angelo Ranaldo & Paul Söderlind, 2015. "Understanding FX Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 28(11), pages 3073-3108.
    7. Moshirian, Fariborz & Qian, Xiaolin & Wee, Claudia Koon Ghee & Zhang, Bohui, 2017. "The determinants and pricing of liquidity commonality around the world," Journal of Financial Markets, Elsevier, vol. 33(C), pages 22-41.
    8. Haugom, Erik & Ray, Rina, 2017. "Heterogeneous traders, liquidity, and volatility in crude oil futures market," Journal of Commodity Markets, Elsevier, vol. 5(C), pages 36-49.
    9. Gregory Connor & Lisa R. Goldberg & Robert A. Korajczyk, 2010. "Portfolio Risk Analysis," Economics Books, Princeton University Press, edition 1, number 9224.
    10. Craig W. Holden & Stacey Jacobsen & Avanidhar Subrahmanyam, 2014. "The Empirical Analysis of Liquidity," Foundations and Trends(R) in Finance, now publishers, vol. 8(4), pages 263-365, December.
    11. Tarun Chordia & Asani Sarkar & Avanidhar Subrahmanyam, 2001. "Common determinants of bond and stock market liquidity: the impact of financial crises, monetary policy, and mutual fund flows," Staff Reports 141, Federal Reserve Bank of New York.
    12. Dimitri Vayanos & Jiang Wang, 2012. "Market Liquidity -- Theory and Empirical Evidence," NBER Working Papers 18251, National Bureau of Economic Research, Inc.
    13. Li, Xiafei & Luo, Di, 2019. "Financial constraints, stock liquidity, and stock returns," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 63(C).
    14. Baker, Malcolm & Stein, Jeremy C., 2004. "Market liquidity as a sentiment indicator," Journal of Financial Markets, Elsevier, vol. 7(3), pages 271-299, June.
    15. K. Lebedeva, 2015. "An Empirical Analysis of the Russian Financial Markets’ Liquidity and Returns," Review of Business and Economics Studies // Review of Business and Economics Studies, Финансовый Университет // Financial University, vol. 3(3), pages 5-31.
    16. Ruenzi, Stefan & Ungeheuer, Michael & Weigert, Florian, 2020. "Joint Extreme events in equity returns and liquidity and their cross-sectional pricing implications," Journal of Banking & Finance, Elsevier, vol. 115(C).
    17. Geert Bekaert & Campbell R. Harvey & Christian Lundblad, 2007. "Liquidity and Expected Returns: Lessons from Emerging Markets," The Review of Financial Studies, Society for Financial Studies, vol. 20(6), pages 1783-1831, November.
    18. Khandani, Amir E. & Lo, Andrew W., 2011. "What happened to the quants in August 2007? Evidence from factors and transactions data," Journal of Financial Markets, Elsevier, vol. 14(1), pages 1-46, February.
    19. Chordia, Tarun & Sarkar, Asani & Subrahmanyam, Avanidhar, 2001. "An Empirical Analysis of Stock and Bond Market Liquidity: Forthcoming in the Review of Financial Studies," University of California at Los Angeles, Anderson Graduate School of Management qt9178v9kq, Anderson Graduate School of Management, UCLA.
    20. Díaz, Antonio & Escribano, Ana, 2020. "Measuring the multi-faceted dimension of liquidity in financial markets: A literature review," Research in International Business and Finance, Elsevier, vol. 51(C).

    More about this item

    Keywords

    money; liquidity; interbank and financial markets; liquidity pull-back;
    All these keywords.

    JEL classification:

    • 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
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:chf:rpseri:rp1025. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Ridima Mittal (email available below). General contact details of provider: https://edirc.repec.org/data/fameech.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.