Latent Liquidity: A new measure of liquidity, with an application to corporate bonds

by Sriketan Mahanti of Orissa Group Inc.,
Amrut Nashikkar of New York University,
Marti Subrahmanyam of New York University,
George Chacko of 6S Capital GmbH, and
Gaurav Mallik of State Street Global Advisors

May 2008

Abstract: We present a new measure of liquidity known as "latent liquidity" and apply it to a unique corporate bond database. Latent liquidity is defined as the weighted average turnover of investors who hold a bond, in which the weights are the fractional investor holdings. It can be used to measure liquidity in markets with sparse transactions data. For bonds that trade frequently, our measure has predictive power for both transaction costs and the price impact of trading, over and above trading activity and bond-specific characteristics thought to be related to liquidity. Additionally, this measure exhibits relationships with bond characteristics similar to those of other trade-based measures.

JEL Classification: G10.

Keywords: Fixed income, Corporate bonds, Liquidity, Asset pricing, Market microstructure.

Published in: Journal of Financial Economics, Vol. 88, No. 2, (May 2008), pp. 272-298.

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