Time Variation in Liquidity: The Role of Market-Maker Inventories and Revenues
Coauthor(s): Carole Comerton-Forde, Terrence Hendershott, Pamela Moulton, Mark Seasholes.
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We show that market-maker balance sheet and income statement variables explain time variation in liquidity, suggesting liquidity-supplier financing constraints matter. Using 11 years of NYSE specialist inventory positions and trading revenues, we find
that aggregate market-level and specialist firm-level spreads widen when specialists have large positions or lose money. The effects are nonlinear and most prominent when inventories are big or trading results have been particularly poor. These sensitivities are smaller after specialist firm mergers, consistent with deep pockets easing
financing constraints. Finally, compared to low volatility stocks, the liquidity of high volatility stocks is more sensitive to inventories and losses.
Source: Journal of Finance
Comerton-Forde, Carole, Terrence Hendershott, Charles Jones, Pamela Moulton, and Mark Seasholes. "Time Variation in Liquidity: The Role of Market-Maker Inventories and Revenues." Journal of Finance 65, no. 1 (2010): 295-331.