Tuesday, May 31, 2016

who supplies liquidity

A BIS empirical working paper on market liquidity provision includes in its abstract the following finding:
We find that proprietary traders, be they fast or slow, provide liquidity with contrarian marketable orders, thus helping the market absorb shocks, even during a crisis, and they earn profits while doing so.
A "marketable" order is one that "takes" liquidity.  So what does this mean?

"Liquidity", even if we've narrowed the topic to "market liquidity", is not at all a single thing.  An investor looking to buy or sell an asset for a few months, especially in a large quantity, can thereby push the market up or down to some degree; the proprietary traders to which they refer presumably are skilled at recognizing the signatures of those distortions, and will tend to enter the market on the other side, such that over the course of a day the net purchase of the proprietary traders and the longer-term investor combined is closer to zero.  The proprietary traders may well exit their positions a week later; they are specialized in more granular timing than the longer-term traders are.  They, however, enter and exit their positions by trading directly with even shorter-term traders, who will typically close their own positions the same day that they take them, and often the same hour.  Many sorts of traders, thus, effectively provide liquidity to those trading on larger time scales than themselves, taking it from those trading on shorter time scales than themselves.

Thursday, May 26, 2016

liquidity and power law behavior

Because I just can't help myself I was reading about self-organized criticality the other day,  That subject is not particularly precisely defined, but there's a nexus of models in which events emergently take place on different scales with a frequency that obeys some power law with respect to the scale.  People certainly find power laws in economics, and I've thought of reasons an economic system might be naturally driven toward critical points, but aside from a brief and particularly fuzzy attempt 25 years ago, there hasn't been much SOC in the economics literature.

I also, you may have noted, have an abiding interest in "liquidity", in its various guises.  One of the key characteristics of liquidity is its heterogeneity; "liquidity shocks", for example, can be idiosyncratic or systemic — or, possibly, somewhere in between.  If I suffer an idiosyncratic liquidity shock, I can sell some assets to other people to raise cash for my sudden needs.  If everyone suffers a liquidity shock at the same time, then nobody else particularly wants to buy; at best, I'm selling at much lower prices to people whose sudden liquidity needs aren't quite as dire as mine.  I haven't seen literature that mentions in-between events, but it would seem reasonable to me that both the contagion effects of liquidity shocks and the triggers of liquidity shocks would have some of the local-interactions-with-threshold-effects characteristics that SOC models tend to have, and would exhibit some of the power law behavior that tends to result.

Friday, May 13, 2016

liquidity, wealth, and consumer behavior

The Atlantic has a contribution to the "it's expensive to be poor" genre of article, and one of the things worth noting about this and most other examples is that the benefit here is generally to liquidity rather than net wealth; I think, though am not sure, that the price-discrimination related reasons that it can be more expensive to be wealthy than poor would track more with net wealth than with liquidity; they would probably track consumption more closely than either.