Chordia, Roll And Subrahmanyam On Commonality

Before this line of research, liquidity was mostly studied stock by stock — each name's bid-ask spread was treated as its own idiosyncratic feature. Chordia, Roll, and Subrahmanyam's 2000 paper "Commonality in Liquidity" showed that individual stocks' spreads and depth co-move significantly with market-wide and industry-wide liquidity measures: when liquidity dries up broadly, it tends to dry up in most individual names at roughly the same time, not just in the ones with firm-specific problems.

This matters because it means liquidity itself behaves like a systematic risk factor, similar to the market factor in asset pricing, rather than something that averages out across a diversified portfolio. If liquidity were purely idiosyncratic, holding many stocks would smooth out any single name's liquidity problems; commonality means a broad-based liquidity crunch hits most of a diversified portfolio's names simultaneously, exactly when a trader is most likely to need to exit quickly.

The mechanism the authors pointed to includes shared funding constraints among market makers (when one dealer pulls back, it affects many names it makes markets in) and correlated trading demand across investors during market-wide stress. This finding underpins later asset-pricing work on liquidity risk premia — the idea that stocks whose liquidity tends to evaporate exactly when market-wide liquidity does should command a higher expected return to compensate holders for that added risk.