Liquidity Marginal Cost and Asset Price Behavior

Abstract

Abstract: This study calculates a new indicator of liquidity named liquidity marginal cost in order to reflect the size of price impact from order flow. This research verifies the effects of liquidity marginal cost on asset price behavior from the perspective of market microstructure and price momentum. The empirical results show that: first, the intraday dynamics of liquidity marginal cost present obvious L-type characteristics and stratification phenomenon. Second, liquidity marginal cost provides a stronger capability of explanation in short-run returns comparing with order flow imbalance. This conclusion remains constant after controlling the company’s market value, order flow imbalance, transaction time and market stage. Third, the effect of liquidity marginal cost on asset price momentum for small market value companies is more remarkable than that for large companies. It verifies that the market manipulation strategies are more appropriate for illiquid assets, which provides new empirical evidence for liquidity and market anomalies.

Key words: liquidity marginal cost, liquidity risk, asset price behavior

Wang Chunfeng, Xiang Jiankai, Li Yang, Fang Zhenming. Liquidity Marginal Cost and Asset Price Behavior[J]. Management Review, 2021, 33(6): 16-28.

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