Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/264583 
Year of Publication: 
2022
Series/Report no.: 
SAFE Working Paper No. 358
Publisher: 
Leibniz Institute for Financial Research SAFE, Frankfurt a. M.
Abstract: 
It is well established that investors price market liquidity risk. Yet, there exists no financial claim contingent on liquidity. We propose a contract to hedge uncertainty over future transaction costs, detailing potential buyers and sellers. Introducing liquidity derivatives in Brunnermeier and Pedersen (2009) improves financial stability by mitigating liquidity spirals. We simulate liquidity option prices for a panel of NYSE stocks spanning 2000 to 2020 by fitting a stochastic process to their bidask spreads. These contracts reduce the exposure to liquidity factors. Their prices provide a novel illiquidity measure reflecting cross-sectional commonalities. Finally, stock returns significantly spread along simulated prices.
Subjects: 
Asset Pricing
Market Liquidity
Liquidity Risk
JEL: 
G12
G13
G17
Document Type: 
Working Paper

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