Friday, June 15, 2007

[Latest Global Dollar Liquidity Measure: +14.4% annual growth rate; latest Endogenous Liquidity Index: +9.7%]

When Mohamed El-Erian mentioned the notion of "endogenous liquidity, the liquidity that the market itself creates", it dawned on me that one could design an index to try and capture changes in the supply of loanable resources derived from financial innovation and from the "Great Moderation" of the business cycle (the two are related, by the way). The result has been our Endogenous Liquidity Index. The ELI includes a number of CDS and high-yield spreads, the VIX, a measure of the carry trade (through short-rate spreads), and ... the Goldman Sachs share price.

While more work needs to be done in terms of CDS spreads and volatility indicators, I am quite confident that such indices will become more and more popular. There is a reason why: as Manuel Johnson and Robert Keleher taught us over ten years ago, globalization and innovation will only increase the value of market-based indicators (*). It was thus with pleasure that I read about Saxo Bank's Steen Jakobsen, "hard at work at designing [a] new monetary index, which includes today's new 'liquidity' generators, credit derivatives and similar structures". Good!

(*) Manuel Johnson & Robert Keleher. Monetary Policy. A Market Price Approach. Westport, Connecticut: Quorum Books, 1996.

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