TY  - JOUR
AU  - Hu,Xing
AU  - Pan,Jun
AU  - Wang,Jiang
TI  - Noise as Information for Illiquidity
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 16468
PY  - 2010
Y2  - October 2010
UR  - http://www.nber.org/papers/w16468
L1  - http://www.nber.org/papers/w16468.pdf
N1  - Author contact info:
Xing Hu
Xing Hu
001 Fisher Hall
Economics Department
Princeton New Jersey 08544
Tel: 6465778676
E-Mail: xinghu@princeton.edu

Jun Pan
MIT Sloan School of Management
100 Main Street, E62-624
Cambridge, MA 02142
Tel: 617/253-3083
Fax: 617/258-6855
E-Mail: junpan@mit.edu

Jiang Wang
MIT Sloan School of Management
100 Main Street, E62-614
Cambridge, MA 02142
Tel: 617/253-2632
Fax: 617/258-6855
E-Mail: wangj@mit.edu
AB  - We propose a broad measure of liquidity for the overall financial market by exploiting its connection with the amount of arbitrage capital in the market and the potential impact on price deviations in US Treasurys.  When arbitrage capital is abundant, we expect the arbitrage forces to smooth out the Treasury yield curve and keep the dispersion low.  During market crises, the shortage of arbitrage capital leaves the yields to move more freely relative to the curve, resulting in more "noise.''  As such, noise in the Treasury market can be informative and we expect this information about liquidity to reflect the broad market conditions because of the central importance of the Treasury market and its low intrinsic noise — high liquidity and low credit risk.  Indeed, we find that our "noise'' measure captures episodes of liquidity crises of different origins and magnitudes and is also related to other known liquidity proxies.  Moreover, using it as a priced risk factor helps explain cross-sectional returns on hedge funds and currency carry trades, both known to be sensitive to the general liquidity conditions of the market.
ER  -