When Market Illiquidity Generates Volume

Serge Darolles, Gaëlle Le Fol, Gulten Mero
2011 Social Science Research Network  
We develop a model of the daily return-volume relationship which incorporates information and liquidity shocks. First, we distinguish between two trading strategies, information-based and liquidity-based trading and suggest that their respective impacts on returns and volume should be modeled differently. Second, we integrate the microstructure setting of Grossman and Miller (1988) with the information flow perspective of Tauchen and Pitts (1983) and derive a modified MDH model with two latent
more » ... el with two latent factors related to information and liquidity. Our model explains how the liquidity frictions can increase the daily traded volume, in the presence of liquidity arbitragers. Finally, we propose a stock-specific liquidity measure using daily return and volume observations of FTSE100 stocks. JEL classification: C51, C52, G12 Tel. +33 (0)1 41 17 77 21. 1 12 GM-process with the second piece of information arriving before trading at date 2 andP 3 being the liquidation value of the asset at the end of the trading day. Note that, z 1 can be expressed as a function of δ 1 :
doi:10.2139/ssrn.1102089 fatcat:qata33vairgwbdfk5pg34t2kve