We study the joint time-series of daily liquidity in government bond and stock markets over the period 1991 to 1998. Innovations in liquidity are positively and significantly correlated across stock and bond markets. Further, order imbalances in the stock market impact bond and stock liquidity, even after controlling for order imbalances in the bond market. Both results suggest the existence of a common liquidity factor in stock and bond markets. We consider monetary conditions and mutual fund flows as sources of order flow and as primitive determinants of liquidity. Monetary expansion enhances stock market liquidity during crises. U.S. government bond funds see higher inflows and equity funds see higher outflows during financial crises, and these flows are associated with decreased liquidity in stock and bond markets. Our results establish a link between “macro” liquidity, or money flows, and “micro” or transactions liquidity.

This paper explores liquidity spillovers in market-capitalization based portfolios of NYSE stocks. Return, volatility, and liquidity dynamics across the small and large cap sector are modeled by way of a vector autoregression model, using data that spans more than 3000 trading days. We find that volatility and liquidity innovations in either sector are informative in predicting liquidity shifts in the other. Impulse responses indicate the existence of persistent liquidity, return, and volatility spillovers across the large and small cap sectors. Lead and lag patterns across small and large cap stocks are stronger when spreads in the large cap sector are wider. Consistent with the notion that private informational trading in large cap stocks is transmitted to other stocks with a lag, order flows in large cap stocks decile significantly predict both transaction price-based and mid-quote returns of small cap deciles when large-cap spreads are high.