Common Factors in Prices, Order Flows and Liquidity
Joel Hasbrock, New York University
Duane J. Seppi, Carnegie Mellon University

How important are cross-stock common factors in the price discovery/liquidity provision process in equity markets? Joel and Duane investigate two aspects of this question for the thirty Dow stocks. Using principal components and canonical correlation analyses they find that both returns and order flows are characterized by common factors. Commonality in the order flows explains roughly half of the commonality in returns. They also examine variation and common covariation in various liquidity proxies and market depth (trade impact) coefficients. Liquidity proxies such as the bid-ask spread and bid-ask quote sizes exhibit time variation which helps explain time variation in trade impacts. The common factors in these liquidity proxies are relatively small, however. (Accepted Late Spring 1999.)