Liquidity, implied volatility and tail risk: A comparison of liquidity measures

Liquidity is easily perceived but not easily measured in financial markets. Researchers and practitioners develop and test new measures of liquidity which may be good candidates for measuring this elusive concept. In this study, we present a comparison of variables within two empirical exercises using up to eight traditional liquidity proxies and two proposed proxies based on semi-deviations in a sample of NYSE-listed stocks. The first empirical exercise analyzes the relationship between liquidity and implied volatility, showing that increases in implied volatility impacts increases illiquidity. Using a decomposition of the squared VIX, we show that both conditional variance and variance premium components affects liquidity. Our second empirical exercise investigates the relationship between common factors in liquidity and tail risk. Common factors increase individual stocks' Value-at-Risk and Expected Shortfall, although the effect is not significant for market risk. In both applications, most of the studied proxies present results aligned with the body of literature. •Increases in implied volatility (VIX) positively affect several illiquidity proxies.•Asset's Value-at-Risk and Expected Shortfall are positively affected by common factors in liquidity.•We propose measures of liquidity based on the semi-deviation of stocks' returns.•Semi-deviation-based measures present similar expected effects when compared to other usual liquidity proxies.