Liquidity: Theory and Empirical Evidence
PhD Topics Course
School of Finance
Shanghai University of Finance and Economics
Instructor: Jason Wei (University of Toronto, wei@rotman.utoronto.ca)
Duration:
June 24 - July 5, 2013
Class time: 8:30am - 11:45am
Office hours: 2:30pm - 4:00pm or by appointment
Class venue: TBA
.
Course description
This course covers one of the most important topics in asset pricing: liquidity. It also covers
another important topic: the motives of option trading. The course title reflects the fact that
the main focus is on liquidity. Option trading will be dealt with at the end of the course.
The main scope of inquiry is empirical, although each topic will start with coverage of the
basic and relevant theories. For instance, before surveying the empirical studies on
liquidity, we will first lay the basic ground work on such things as information modeling,
concept of equilibrium, and market efficiency, followed by the introduction of the classic
models on bid-ask spreads and price impacts (e.g., Kyle, 1985; and Glosten and Milgrom,
1985).
Course materials and class preparations
Since this is a topics course, no textbook is assigned. Journal articles are the main subjects
of study. For students' convenience, a detailed lecturing plan is attached. Students are
encouraged to read all the papers beforehand (at least familiarizing themselves with the
general contents, if not every single detail). Hard copies of PPT slides will be distributed
before classes. Needless to say, not every paper on the list can/will be covered in detail
given time constraint.
Requirements and performance evaluation
Registered students should attend each and every lecture. Class participation is greatly
encouraged. There will be two components of evaluation, with the first being a pre-course
assignment and the second being a research proposal. Both components are to be
completed individually (i.e., they cannot be submitted in groups).
The first component, which is worth 30%, is due on the first day of lecture, June 24. This
pre-course assignment has two elements. First, list, define and evaluate all
liquidity/illiquidity measures that you know of for stocks, bonds and options. By "evaluate"
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I mean comments on the pros and cons of each measure. For the second element, briefly
discuss the motives/reasons for options trading (i.e., why options are being traded). There
are no specific requirements on the format of the assignment, except that it should be typed,
in English, double-spaced, and no more than 10 pages. As you can see, the main purpose of
this assignment is for you to get a rough picture of the topics to be covered in this course.
You will need to do some rudimental research, but you are not expected to study the
literature closely for this assignment. Submissions with precise definitions and insightful
discussions will earn higher marks.
The second component of the course evaluation, which is worth 70%, is a research
proposal which is due two weeks after the last day of lecture, i.e., July 19. Each student shall
propose a research topic loosely related to the topics covered in class (i.e., liquidity or
option trading). The research proposal will be judged on its novelty, potential contribution
to the literature, and feasibility. The proposal should not be a mere literature review.
Although necessary for motivation, literature review should be kept at the minimum. The
bulk of the proposal should delineate why the study is new and how it contributes to the
literature. There are no specific requirements on the length and format of the proposal,
although common sense says that a sound proposal with a clearly articulated motivation
and execution plan may take at least a few pages.
If, in my opinion, the proposal has good potential, I may invite the student to be a co-author
and formally pursue the idea (if the student is interested).
Insofar as this course outline is made available to students well ahead of the course,
students will have plenty of time to work on the two components.
Lecturing schedule
The course spans a two-week period (June 24 - July 5, inclusive). In order for students to
fully absorb the materials, each lecture will last for a little over three hours (8:30am 11:45am), and there will be only nine lectures: June 24, 25, 26, 27, and July 1-5. Depending
on the progress, there might be added lectures on one or two afternoons. Students will be
informed well in advance if an extra lecture is needed.
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Detailed outline
I. General introduction: Primer on information modelling, equilibrium, rational
expectations, trading and market efficiency
Modelling information, concepts of equilibrium
Definitions of (noisy) rational expectations
Market efficiency
Grossman and Stiglitz (1980)
II. Liquidity
1. Classic theories on liquidity–bid-ask spread and price impact
Brief intro to the birth of microstructure
Bid-ask spread – inventory risk perspective (Garman, 1976; Amihud and
Mendelson, 1980; Stoll, 1978)
Price impact – Kyle's lamda (Kyle, 1985)
Bid-ask spread – adverse selection perspective (Glosten and Milgrom, 1985)
Bid-ask spread – adverse selection perspective (Easley and O'Hara, 1987)
Role of noise traders (Admati and Pfleiderer, 1988; Foster and Viswanathan,
1990; and Spiegel and Subrahmanyam, 1992)
2. A brief survey of empirical liquidity measures
3. Empirical evidence on liquidity - equity markets
3.1
3.2
3.3
Cross-section studies of liquidity effects
Amihud and Mendelson (1986)
Brennan and Subrahmanyam (1996)
Amihud (2002)
Time-series studies of liquidity effects
Amihud (2002)
Jones (2002)
Bekaert, Harvey and Lundblad (2007) (only a brief review of this paper)
Pricing of liquidity risk
Pastor and Stambaugh (2003)
Acharya and Pedersen (2005)
Sadka (2006)
Amihud, Hameed, Kang and Zhang (2012)
4. Empirical evidence on liquidity - bond markets
4.1
4.2
Treasury bonds
Amihud and Mendelson (1991)
Warga (1992), Kamara (1994), Goldreich et al. (2005)
Liquidity effects in corporate bonds
Chen, Lesmond and Wei (2007)
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4.3
liquidity effects and risk in corporate bonds
de Jong and Driessen (2006 → 2012)
Bao, Pan and Wang (2011)
Lin, Wang and Wu (2011)
Acharya, Amihud and Bharath (2013)
5. Empirical evidence on liquidity - options markets
Cho and Engle (1999)
Wei and Zheng (2010)
Cao and Wei (2010)
Christoffersen, Goyenko, Jacobs and Karoui (2012)
III. Option trading
1. General theories on information and trading
information structure and trading
herding and information cascades
2. Trading due to information and differences of opinion
information: Easley, O'Hara and Srinivas (1998)
differences of opinion (Harris and Raviv, 1993; Kandel and Pearson, 1995;
and Kim and Verrecchia, 1994)
3. Survey of the empirical literature
Informed trading
 lead-lag, price discovery, information share
 Stephane and Whaley (1990)
 Chan, Chung and Johnson (1993)
 Easley, O'Hara and Srinivas (1998) – empirical part
 Chan, Chung and Fong (2002)
 Chakrabarty, Gulen and Mayhew (2004)
 Muravyev, Pearson and Broussard (2013)
 event studies
 Amin and Lee (1997)
 Cao, Chen and Griffin (2005)
 directional: Pan and Poteshman (2006)
 volatility: Ni, Pan and Poteshman (2008)
Differences of opinion and speculation: Choy and Wei (2012)
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