Evaporating Liquidity in Brazil

Advisor: Marcelo Medeiros

Co-advisor: Pablo Hector Seuanez Salgado

Literature shows that short-term reversal strategies in equity markets
can be interpreted as a proxy for liquidity provision. This study examines
whether the short-term reversal strategy bears similar results in Brazil, a way
less developed and illiquid market. On the developed American stock markets,
the expected return of such a strategy appears to be lucrative, strongly timevarying and highly predictable with liquidity and fear indexes such as the VIX
index. In the Brazilian, more volatile market, the profitability of such a strategy
seem to have reduced in the latest years, and contrary to expectations, the
EMBI+ Brazil is the only index with predictive power over such returns while
the VIX-EWZ and the Ivol-BR, both proxies to what would be a Brazilian VIX
have no predictive power. The expected returns of providing liquidity seem to
rise in times of increased risk perception, which indicates that withdrawal of
liquidity supply, translated in an increase in the expected returns from liquidity
provision, is one of the drivers behind the evaporation of liquidity in times of
market turmoil even in developing countries.