Measures Of Market Liquidity Research Articles

Does high-frequency trading actually improve market liquidity? A comparative study for selected models and measures

The increasing volume of messages sent to the exchange by algorithmic traders stimulates a fierce debate among academics and practitioners on the impacts of high-frequency trading (HFT) on capital markets. By comparing a variety of regression models that associate various measures of market liquidity with measures of high-frequency activity on the same dataset, we find that for some models the increase in high-frequency activity improves market liquidity, but for others, we get the opposite effect. We indicate that this ambiguity does not depend only on the stock market or the data period, but also on the used HFT measure: the increase of high-frequency orders leads to lower market liquidity whereas the increase in high-frequency trades improves liquidity. We hypothesize that the observed decrease in market liquidity associated with an increasing level of high-frequency orders is caused by a rise in quote volatility.

The Market Liquidity Of Designated 2B Equity Securities Under The Basel Accord: Empirical Evidence From South African Commercial Banks

Purpose: The financial market liquidity of an asset has always been an important concept in banking and financial markets because it keeps leveraging in check. The objective of this study was to investigate the market liquidity of the level 2B common equity in the Liquidity Coverage Ratio and Net Stable Fund Ratio. Market liquidity measures where modelled and tested empirically to validate whether the LCR and NSFR needs to be improved. Methodology: This study used a sample period from May 2016 – May 2021, and a fixed effect model to investigate the market liquidity of the selected level 2B High Quality Liquid Assets. Findings: The findings of this study indicates that the common equity securities that qualifies to be included in level 2B HQLA category lack market depth. This was evident in the significant relationship between the independent and dependent variables used in this study although there was no significant relationship between transaction cost and price effect. Therefore, there was sufficient evidence that the LCR and NSFR measures for liquidity management in the banking sector needs to be improved. Originality/Value: An improved LCR and NSFR was suggested in addition to a specialist system in order to capture the volatility of the level 2B equity securities and improve the market liquidity of these assets. As per the author’s knowledge, this study is the first study to empirically investigate the liquidity of the selected level 2B HQLAs.

Trading Volume and Capital Gains Tax - Evidence from Selected Stock Markets with Different Characteristics

The purpose of the article/hypothesis: The goal of this paper is to investigate the relationship between capital gains tax paid by investors and the liquidity of the market, expressed by the trading volume.
 Methodology: In this study, the measure of market liquidity, expressed by the trading volume, has been proposed as a variable that may be influenced by taxes on capital gains. The article presents a new approach to the analysis of the liquidity of capital markets.
 Results of the research: Based on the data analysis, it was found that the higher the taxes on capital gains are paid by investors, the less likely they are to take their profits, and this is the situation on a highly developed market (the analysed US market). However, as it turns out from the results obtained, in the case of European countries representing stock markets after the systemic transformation, the higher the taxes on capital gains, the higher the share trading in these markets should be.

Pricing vulnerable options with stochastic liquidity risk

In this paper, we consider vulnerable options with stochastic liquidity risk. We employ liquidity-adjusted pricing models to describe the underlying stock price and option issuer’s assets. In addition, the correlation between these assets is stochastic, depending on the market liquidity measures. In the proposed framework, we derive closed forms of vulnerable European options with stochastic liquidity risk and then use them to illustrate the effects of stochastic liquidity risk on vulnerable option prices. Numerical results show that the effects of liquidity risk on the prices of out-of-the-money options or the options with a short maturity are not negligible.

Monetary Policy and Stock Market Liquidity in Emerging Market Economies

In the era of globalization, the financial systems of all countries have faced severe challenges and their negative impacts such as overheated economy, high inflation, stock market crash, financial crisis, and other financial collapses. It has raised significant concerns influencing the effects of macroeconomic policies and responses of the financial system of each country all over the world even in normal times and turbulent times in various respects. And stock markets in emerging market economies are no exceptions. Indeed, it is proven by more and more studies that have been implemented to assess stock market liquidity in emerging market economies in different periods and the impacts of certain macroeconomic drivers on monetary policy. This study aimed to systematically review the literature on monetary policy and stock market liquidity measures and how monetary policy affects stock market liquidity. The study summarized the essential findings and approaches in the extant literature. Numerous reputable academic databases were used via a systematic methodology of literature review. Generally, this study sheds light on the crucial macroeconomic role of monetary policy as a potential determinant of stock market liquidity in different timelines. Recommendations and theoretical discussions given by researchers provide an overall review of the relationship between monetary policy and stock market liquidity in emerging market economies.

Commonalities in Private Commercial Real Estate Market Liquidity and Price Index Returns

AbstractWe examine co-movements in private commercial real estate index returns and market liquidity in the US (apartment, office, retail) and for eighteen global cities, using data from Real Capital Analytics over the period 2005–2018. Our measure of market liquidity is based on the difference between supply and demand price indexes. We document for all analyzed markets much stronger commonalities in changes in market liquidity compared to commonalities in real price index returns. We further provide empirical evidence that space markets are less integrated than capital markets by analyzing co-movements in net-operating-income and cap rate spreads (over similar maturity bond yields). In a theoretical simulation model, we show that the strong integration of capital markets compared to space markets, is in fact the reason why market liquidity co-moves so strongly compared to returns. Our results are of interest for large private real estate investors such as pension funds and other institutional investors who are interested in spreading risk. Our findings imply that fully diversified price return benefits may be difficult to obtain, because market liquidity may dry up in all markets simultaneously, which makes portfolio re-balancing more difficult and costly.

Liquidity measurement: A comparative review of the literature with a focus on high frequency

AbstractThis paper provides an exhaustive review and categorization of market liquidity measures that are used to quantify liquidity in empirical research. We review and discuss these measures in a comparative manner in terms of market, data features, computational ease, predictiveness, and potentiality. With a primary focus on high‐frequency liquidity measurement, we highlight their advantages, limitations, and extensions. We conclude that high‐frequency measures concentrate around bid–ask spread and limit order book, the latter offering a richer ground for analysis. Moreover, considering the recent developments in the industry such as market fragmentation, abundance of data, and improved technology, the practicality of these measures are challenged.

Funding liquidity and market liquidity in government bonds

Using a comprehensive dataset of orders and trades in the Indian government bond market, this study presents new evidence on the effect of funding liquidity on market liquidity. We find no evidence that lower short-term interest rates – the key instruments of monetary policy – boost market liquidity. However, consistent with models that stress the role of intermediary capital, we find that market liquidity measures have a strong, positive association with short-term borrowing by primary dealers. We provide additional evidence linking these firms’ borrowing to their balance sheet strength and secondary market participation. The results suggest that localized funding conditions specific to marginal suppliers of intermediation services are more important for market liquidity than the broader economy-wide funding environment.

Multidimensional Stock Market Liquidity and Business Cycles

We examine the impact of multidimensional stock market liquidity on business cycles that captures the key market liquidity characteristics. Using seven different liquidity measures, we find that the effect of liquidity on economic growth and recessions differs among liquidity measures in the US stock market in the period of 1952 to 2011. Volume-based and transaction costs-based measures contain robust information about future conditions of the US economy, while for market-impact and price-based measures there is no causality in either direction. Moreover, the illiquidity ratio dominates all stock market liquidity measures in forecasting economic recessions. Our findings exemplify the importance of alternative liquidity proxies in explaining the state of the US economy.

The Impact of Investor Sentiment on Stock Market Liquidity: The Mediating Role of Investor Herding Behavior “An Empirical Study on the Egyptian Stock Exchange”

Behavioral finance is a recent approach in financial markets that have appeared because of the complexities long faced by the traditional or neoclassical finance theory. This paper investigates the influence of investor sentiment and herding behaviour on stock market liquidity using an empirical study on the Egyptian Stock Market. We examine the direct impact of Egyptian investor sentiment on the Egyptian Stock Market liquidity. As well as the indirect impact of the Egyptian investor sentiment on the Egyptian Stock Market liquidity through the Egyptian investor herding behaviour. Therefore, the major contribution is filling the gap of indirect sentiment-liquidity impact conflict. We use the monthly data of the EGX30 index from January 2004 up to December 2018 for building up investor sentiment index, investor herding behaviour, and stock market liquidity measures. Moreover, we are using two additional types of data (closed-end mutual fund discounts and the equity open-end mutual fund flows) that represent major measures which are used to build up investor sentiment index ranging through the same time-series of the previously mentioned period of this paper. Additionally, we use four control variables for stock market liquidity, namely market volatility, excess market return, term spread, and lag of the dependent variable, considering that the fourth variable is also used for investor herding behaviour. Our result shows that the investor sentiment index has both a direct and indirect impact on stock market liquidity. In addition, regarding event study analysis’ results, there are different signs of the direct and indirect impacts and different correlations between the research variables throughout the four different events that differ completely from the usual signs and correlations of the theoretical background.

Momentum crashes and variations to market liquidity

AbstractWe document that the variation in market liquidity is an important determinant of momentum crashes that is independent of other known explanations. This relationship is driven by the asymmetric large return sensitivity of short‐leg of momentum portfolio to changes in market liquidity that increases the tail risk of the momentum strategy in panic states. Identifying this partly explains the forecasting ability of known predictors of tail risk of the momentum strategy. The contemporaneous increase in market liquidity explains, to some extent, the documented negative relationship between predictors and future momentum returns. Our findings are robust to the use of alternative measures of market liquidity that share a common source of variation in aggregate liquidity.

The dynamic relationship between internet attention and stock market liquidity: A thermal optimal path method

Financial theory holds that attention plays a significant role in the information response, and internet attention has been used widely to explore their influence on stock market microstructure. Based on the thermal optimal path method and social network data, this paper constructs two dynamic variables including investor and media attention reflecting the internet attention and examines the lead–lag relationship between the internet attention and market liquidity measures. Furthermore, the sample is further divided into three parts including stationary and fluctuation periods to explore the predictive ability of internet attention effects on Chinese stock market liquidity. The main results reveal that the lead–lag orders between the internet attention and market liquidity are not always positive or negative. In other words, the internet attention does not always dominate the stock market liquidity, and vice versa. Moreover, there are significant differences in the results of lead–lag orders between three different subsample periods. The empirical results confirm that internet attention facilitates forecasting market performance in the Chinese stock market, and supplements the relevant theories of stock market trading and behavioral finance from the perspective of econophysics.

Google Search Volume and Stock Market Liquidity

Our research showed that search volume on Google serves or GSV as an intuitive proxy for overall stock market recognition. We proposed a predictive parsimonious model TFARM (two factor auto-regressive methodology) on stock market liquidity measures (bid - ask spread, market efficiency coefficient, trading probability, turnover ratio (TR), and total volume (TV)) and employed public and free information such as GSV (Google search volume) on a dataset from NSE (National Stock Exchange) for period between 2004-2016 divided into pre, during, and post subprime crisis of 2007-2008. We found that an increase in Google search queries was linked to a rise in stock liquidity and trading activity. We characterized the improved liquidity to a decrease in asymmetric information costs and thus, concluded that GSV mainly measured attention from uninformed investors. Moreover, we found evidence that an increase in search volume was associated with temporarily higher future returns, which reinforced the previous findings. Impact of GSV on both TV and TR in terms of direction was similar in nature and consistent with the findings of Preis, Moat, and Stanley (2013).

Audit Committee Financial Expertise and Information Asymmetry

We examine the association between audit-committee expertise and asymmetric information in the U.S. equity market. Using precise private information extracted from a decomposed bid-ask spread, we find that the existence of an audit committee with financial expertise is negatively associated with information asymmetry. We further find CEO duality to mediate the association between audit-committee financial expertise and information asymmetry. More specifically, we document a significant positive association between the interaction term of CEO duality and audit-committee financial expertise and information asymmetry. Our results are robust to several market-microstructure measures of asymmetric information (e.g., quoted spread, effective spread, price impact, the probability of informed trading), firm-specific characteristics, and market-liquidity measures.

Momentum Crashes and Variations to Market Liquidity

We document that the variation in market liquidity is an important determinant of momentum crashes that is independent of other known explanations surfaced on this topic. This relationship is driven by the asymmetric large return sensitivity of short-leg of momentum portfolio to changes in market liquidity that flares the tail risk of momentum strategy in panic states. This identification explains the forecasting ability of known predictors of tail risk of momentum strategy such that the contemporaneous increase in market liquidity predominantly sums up the trademark negative relationship between predictors and future momentum returns. Our results are robust using a different momentum portfolio and alternative measures of market liquidity that make a substantial part of the common source of variation in aggregate liquidity.

Sentiment trading, informed trading and dynamic asset pricing

This paper investigates the investor trading behavior in a dynamic setting. We present a continuous trading sentiment asset pricing model under asymmetric information. In the model, the informed rational investor trades on information so that the information is factored into prices gradually, while the sentiment investor trades on sentiment as if it were information. We find that sentiment trading not only increases the measure of market liquidity, but also makes the market imperfect. Moreover, all information is incorporated into prices by the end of trading in the continuous trading equilibrium. In addition to providing a unified explanation to some anomalies such as underreaction, momentum effect, reversal effect and so on, the model generates several other distinctive implications.

Mind the Gap: Disentangling Credit and Liquidity in Risk Spreads*

Euro-area sovereign bond and interbank interest rate spreads spiked in the 2007–2009 Global Financial Crisis and the subsequent European Debt Crisis, substantially elevating financing costs. I use a model-free measure of market liquidity to precisely identify the relative contribution of credit versus liquidity to spreads in these episodes. In the Financial Crisis, liquidity is paramount, accounting for 36% of trough-to-peak widening, after controlling for credit. However, default risk becomes relatively more important to sovereign spreads in the Debt Crisis. Aggregate bond liquidity explains a substantial portion of interbank spreads throughout the sample.

Social trust and the liquidity of cross-listed securities

This paper examines various measures of market liquidity in American Depositary Receipts (ADRs) while conditioning on the level of trust in the ADR's home country. Multivariate tests show that as home-country levels of trust increase, ADR liquidity is dramatically improved. To draw stronger causal inferences, we use a difference-in-difference approach to examine liquidity surrounding an (arguably) exogenous reduction in trust and find that liquidity worsens in response to the event. These results support our hypothesis that trust is an important determinant in the liquidity of financial markets.

The liquidity of the London capital markets, 1825–70†

AbstractThis article examines the liquidity of the London capital markets in the decades following the liberalization of UK incorporation law. Using comprehensive stock and bond data, we calculate a measure of market liquidity for the period 1825–70. We find that stock market liquidity trended upwards but bond market liquidity did not increase over the sample period. Stock market liquidity during our sample period was partially influenced by the bond market, rather than fluctuations in economic output. In our analysis of the cross‐sectional determinants of individual stock liquidity, we find that firm size and the number of issued shares were important determinants of liquidity. Finally, we find little evidence of an illiquidity premium, which is consistent with the view that investors did not price liquidity in this nascent market.

An Empirical Investigation on Funding Liquidity and Market Liquidity*

In empirically exploring the link between funding liquidity and market liquidity, the greatest challenge is to designate a suitable market that shows such linkages. In this respect, the 15-year Japanese floating (JF)-rate bond market, characterized by the lack of diversity among highly leveraged trading strategies, is an ideal case for investigation. A clean measure of market liquidity, liquidity discount rate (LDR), is estimated from JF prices and the LDR is found to be intertwined with funding liquidity only during the crisis. The deterioration of funding liquidity precedes that of the LDR, thus providing evidence of the outbreak of liquidity spiral.