recent developments in high frequency financial ... - Index of

Pierre Giot . Joachim Grammig
How large is liquidity risk in an automated
auction market?
Abstract We introduce a new empirical methodology that models liquidity risk
over short time periods for impatient traders who submit market orders. Using
Value-at-Risk type measures, we quantify the liquidity risk premia for portfolios
and individual stocks traded on the automated auction market Xetra. The specificity
of our approach relies on the adequate econometric modelling of the
potential price impact incurred by the liquidation of a portfolio. We study the
sensitivity of liquidity risk towards portfolio size and traders’ time horizon, and
interpret its diurnal variation in the light of market microstructure theory.
1 Introduction
In economics and finance, the notion of liquidity is generally conceived as the
ability to trade quickly a large volume with minimal price impact. In an attempt to
grasp the concept more precisely, Kyle (1985) identifies three dimensions of
liquidity: tightness (reflected in the bid–ask spread), depth (the amount of onesided
volume that can be absorbed by the market without causing a revision of the
bid-ask prices), and resiliency (the speed of return to equilibrium). In modern
automated auction markets, the liquidity supply solely depends on the state of the
electronic order book which consists of previously entered, non-executed limit buy
and sell orders. This set of standing orders determines the price-volume rela-
P. Giot
Department of Business Administration & CEREFIM, University of Namur,
Rempart de la Vierge, 8, 5000 Namur, Belgium
P. Giot
CORE, Université catholique de Louvain, Louvain, Belgium
E-mail: pierre.giot@fundp.ac.be
J. Grammig (*)
Faculty of Economics, University of Tübingen, Mohlstrasse 36, 72074 Tübingen, Germany
E-mail: joachim.grammig@uni-tuebingen.de
J. Grammig
Centre for Financial Research, Cologne, Germany