Measuring liquidity commonality in financial markets

This paper contributes to the literature by developing a new methodology, termed as the beta index, for measuring liquidity commonality in financial markets, that is derived from the dynamics of liquidity co-movements. We show that computing the beta index is a straightforward process. In addition, not only is the proposed beta index more efficient in controlling for confounding factors and addressing the associated statistical inference issues, but also it will enhance the accuracy of estimation. We apply the beta index to track the liquidity commonality in the foreign exchange market over the study period and identify important financial and economic events that caused liquidity commonality. We detect periods of high and low liquidity commonalities that especially would benefit active market traders who frequently rebalance portfolios and require knowledge of liquidity commonality as an input to give an important early signal and implication on diversification benefit.