Liquidity Measurement Problems in Fast, Competitive Markets: Expensive and Cheap Solutions




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    • Craig W. Holden is at the Kelley School of Business, Indiana University. Stacey Jacobsen is at the Cox School of Business, Southern Methodist University. We thank Jim Upson for helpful institutional and DTAQ comments. We thank Campbell Harvey (the Editor), an anonymous Associate Editor, an anonymous referee, Ekkehart Boehmer, Charles Collver, Terrence Hendershott, Bob Jennings, Hung-Neng Lai, Qin Lei, Bill Maxwell, Darius Miller, Pamela Moulton, Maureen O'Hara, Kumar Venkataraman, and seminar participants at Indiana University and Southern Methodist University. We are solely responsible for any errors.


Do fast, competitive markets yield liquidity measurement problems when using the popular Monthly Trade and Quote (MTAQ) database? Yes. MTAQ yields distorted measures of spreads, trade location, and price impact compared with the expensive Daily Trade and Quote (DTAQ) database. These problems are driven by (1) withdrawn quotes, (2) second (versus millisecond) time stamps, and (3) other causes, including canceled quotes. The expensive solution, using DTAQ, is first-best. For financially constrained researchers, the cheap solution—using MTAQ with our new Interpolated Time technique, adjusting for withdrawn quotes, and deleting economically nonsensical states—is second-best. These solutions change research inferences.