2024/03/30 by Qi Deng, Deng, Qi
Economics, Econometrics and Finance · #FOS: Economics and business #Financial Markets and Investment Strategies #Portfolio Management (q-fin.PM) #Statistical Finance (q-fin.ST) #Stochastic processes and financial applications
paper · pdf · doi:10.48550/arxiv.2407.00813
openalex publication_date 2024/03/30 · openalex created_date 2024/07/06 · openalex updated_date 2026/07/28
We develop a liquidity-sensitive multivariate volatility framework to improve the estimation of time-varying covariance structures under market frictions. We introduce two novel portfolio-level liquidity measures, liquidity jump and liquidity diffusion, which capture magnitude and volatility of liquidity fluctuation, respectively, and construct liquidity-adjusted return and volatility that reflect real-time liquidity variability. These liquidity-adjusted inputs are integrated into a VECM-DCC/ADCC-Bayesian model, allowing for conditional and posterior covariance estimation under liquidity stress. Applying this framework to portfolios of cryptocurrencies and US stocks, we find that traditional models misrepresent volatility and co-movement, while liquidity-adjusted models yield more stable and interpretable risk structures, particularly for portfolios of cryptocurrencies. The findings support the use of liquidity-adjusted multivariate models as statistically grounded tools for assessing the propagation of portfolio risk under market frictions, with implications for asset pricing, market microstructure design, and portfolio management.