Time Variation in Liquidity: The Role of Market‐Maker Inventories and Revenues

TLDR

The study uses 11 years of NYSE specialist inventory and revenue data to show that market‑level and specialist‑firm spreads widen when specialists hold large inventories or incur losses. Market‑maker balance sheet and income statement variables explain liquidity variation, with spreads widening nonlinearly when specialists hold large inventories or incur losses, effects that are attenuated after mergers and are more pronounced for high‑volatility stocks.

Abstract

ABSTRACT We show that market‐maker balance sheet and income statement variables explain time variation in liquidity, suggesting liquidity‐supplier financing constraints matter. Using 11 years of NYSE specialist inventory positions and trading revenues, we find that aggregate market‐level and specialist firm‐level spreads widen when specialists have large positions or lose money. The effects are nonlinear and most prominent when inventories are big or trading results have been particularly poor. These sensitivities are smaller after specialist firm mergers, consistent with deep pockets easing financing constraints. Finally, compared to low volatility stocks, the liquidity of high volatility stocks is more sensitive to inventories and losses.