Why No Liquidity Futures?
A slight digression from the topic here, but the following is from Bill Gross of PIMCO (writing in the Washington Post and echoing a point I’ve heard elsewhere):
While the newborn derivatives may hedge individual, institutional and sector risk, they cannot hedge liquidity risk.That’s true. But why? Why aren’t there derivatives to hedge liquidity risk? Surely it’s possible to create a futures contract on a bid-ask spread (or maybe separate futures on the bid and the ask). Market-makers could even use the contracts to hedge against excessive liquidity. The contracts would require some kind of rule for dealing with situations when there is no observed bid, as is apparently the case with many mortgage-backed securities today, but presumably a rule can be worked out.