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







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    • Comerton-Forde is at University of Sydney. Hendershott is at Haas School of Business, University of California Berkeley. Jones is at Columbia Business School. Moulton is at Fordham Graduate School of Business. Seasholes is at Hong Kong University of Science and Technology. We thank the NYSE for providing data. We thank Cam Harvey, an associate editor, two anonymous referees, Yakov Amihud, Jeff Benton, Ekkehart Boehmer, Robin Greenwood, Joel Hasbrouck, Jerry Liu, Marios Panayides, L̆ubos̆ Pástor, Avanidhar Subrahmanyam, Dimitri Vayanos, Vish Viswanathan, Masahiro Watanabe, Pierre-Olivier Weill, and participants at the NBER Market Microstructure meeting, the Trading Frictions in Asset Markets conference at UCSB, the 2008 AFA meeting, Columbia University, the Federal Reserve Bank of New York, University of Maryland, University of Michigan, the Office of Economic Analysis of the U.S. Securities and Exchange Commission, Society of Quantitative Analysts, University of Amsterdam, University of California Santa Barbara, University of Toronto, University of Utah, and University of Washington for helpful comments. Hendershott gratefully acknowledges support from the National Science Foundation. Part of this research was conducted while Moulton was an economist and Comerton-Forde and Hendershott were visiting economists at the New York Stock Exchange. This paper combines two working papers by subsets of the authors: “Market Maker Inventories and Liquidity” and “Market Maker Revenues and Stock Market Liquidity.”


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.