Understanding Liquidity and How to Measure It

Yarilet Perez is an experienced multimedia journalist and fact-checker with a Master of Science in Journalism. She has worked in multiple cities covering breaking news, politics, education, and more. The scale of the purchases, not only Treasuries but also agencies and mortgage-backed securities, has ballooned the central bank’s balance sheet to roughly $9 trillion . That accounts for nearly 20% of the US government’s more than $30 trillion in total debt outstanding.

The simple CRSP-based spread provides a better approximation of the TAQ-based spread than all other low-frequency liquidity measures in cross-sectional settings. However, the CRSP-based spread is highly correlated with the TAQ spread in time-series settings only for NASDAQ stocks. Overall, our results suggest that the simple CRSP-based spread could be used in lieu of the TAQ-based spread in academic research that focuses on cross-sectional analysis. We examine how liquidity affects cryptocurrency market efficiency and study commonalities in anomaly performance in cryptocurrency markets. Empirically, we observe that many widely recognized stock market anomalies also exist in the cryptocurrency market, although some have opposite long and short legs. We also find evidence that a decrease in cryptocurrency liquidity enhances anomalous returns while preventing the cryptocurrency market from achieving efficiency.

Meanwhile, market-to-book ratio is found significantly negatively correlated with stock profits. Yet, market-to-book ratio has a significant and positive nexus with market depth and tightness. Nevertheless, the regression results of the two models show a significantly negative correlation between market capitalization and both market depth and tightness as advocated by a study of Mdaghri et al. . One notable finding in this study is the significant and positive influence of COVID-19 lockdown on the stock returns and liquidity of Vietnamese banking, finance and insurance firms. The rationale behind this is a boost to investor confidence toward the Government’s timely and effective containment strategies in response to the pandemic, especially during the lockdown periods.

Banking

In turn, this increased foreign investment could fill another void in end-user demand. On March 20th, 2020, the Ministry of Health announced the 86th and 87th COVID-19 patients who were two female nurses working at the Tropical Diseases Center of Bach Mai Hospital . As of March 21st, 2020, Vietnam declared a temporary suspension of entry for all foreigners.

Even the most sophisticated financial products are not immune to the physical Law of Conservation of Matter–the risk must rest somewhere. Hedge funds reportedly have served as willing buyers of these riskier positions, and we are all aware of their phenomenal growth. As important as the participation of hedge funds, the derivative products themselves allow credit risk to be hedged, which has the beneficial effect of further increasing the pool of other investors as well. The increase in financial product and provider innovation appears to be quite persistent; future trends, however, are likely to be significantly influenced by legal, regulatory, and other public policies. The shares of companies that are traded on major stock exchanges tend to be highly liquid.

Liquidity Example (Balance Sheet)

Exotic currency pairs comprise of a major pair being traded alongside the currency of a developing or emerging market – such as the Mexican peso, Hong Kong dollar or the Turkish Lira. By definition, exotic pairs are more thinly traded, which means that they have far less liquidity when compared to the major pairs. In forex, liquidity matters because it tends to reduce the risk of slippage, gives faster execution of orders and tighter bid-offer spreads.

He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem. One is for federal regulators to repeat what they did in March 2020—namely, relieve market makers of SLR requirements that include US Treasuries. This move improved how to find liquidity provider considerably, as the Fed itself acknowledged. There’s reason to believe the Fed would go this route again, after new vice chair for supervision Michael Barr suggested to lawmakers that he’d consider changes to SLR requirements.

Institutional aspects of European equity markets

Therefore, a study on the influence of the COVID-19 pandemic on the stock profitability and liquidity of listed companies in this sector is undoubtedly crucial to the development of Vietnam’s stock market. This is the first study to explore the influence of the COVID-19 outbreak and the Government’s disease control measures on the stock returns and liquidity of Vietnam-listed companies in the financial services industry. This paper aims to explore the influence of the COVID-19 outbreak and the Government’s disease control measures on the stock returns and liquidity of Vietnam-listed companies in the financial services sector.

But, with new regulations punishing such trading , banks and other financial institutions have reduced their market-making activity. So, in times of surprise that move bond prices and yields, the banks are not present to act as stabilizers. On the basis of empirical results, this paper proposes several implications for the Government and investors. In addition, investors need to carefully consider whether a company has sustainable business performance and corporate governance in the long term to avoid or minimize the impact of a new outbreak and other unforeseeable events. This would also help investors seize investment opportunities that optimize profits or mitigate losses.

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The two main types of liquidity include market liquidity and accounting liquidity. Another welcome outcome would involve a decline in the US dollar and subsequently lower hedging costs. We expect this would re-engage some foreign investors who have withdrawn from US Treasuries to stabilize domestic currency valuations and deploy assets for local financing needs.

• In a worst-case scenario, depositors may demand their funds when the bank is unable to generate adequate cash without incurring substantial financial losses.
• The study also investigates the impact of the COVID-19 epidemic on financial services institutions with different sizes of market capitalization.
• This can be attributed to the industry’s sensibility and vulnerability toward the risk of increasing bad debts and unusually large-scale deposit withdrawals .
• Financial analysts look at a firm’s ability to use liquid assets to cover its short-term obligations.
• Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance.
• Traditionally, commodity markets were considered significantly less liquid than other markets because the physical delivery of assets made them difficult to speculate on.

Since then, Vietnam has experienced a rapid-spreading outbreak both in quarantine camps and in the community. With this stance, the Government of Vietnam has tightened the COVID-19 restrictions to curb a new wave of infections. In the afternoon of May 15th, 2021, the Ministry of Health announced the 36th COVID-19-related death, also known as the 3839th confirmed patient in Bac Ninh Province. This event has remarked the most severe outbreak since the onset of the COVID-19 epidemic in Vietnam so far.

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Figure 3 indicates the daily confirmed patients and deaths related to the COVID-19 epidemic. The authors expect an inverse relationship between the severity of the pandemic situation and the stock profitability and liquidity of companies in the sample, especially for the period from July 31st, 2020 onward. Simultaneously, the research assesses the influence of the COVID-19 surges on the profitability and liquidity of large-cap and small-cap companies. We extend the period of observations from January 30th, 2020 to May 15th, 2021. We propose a modified version of the Amihud illiquidity measure, AdjILLIQ, which performs well in different types of emerging markets. Our AdjILLIQ measure combines the virtues of the original Amihud ratio and the non-trading-frequency measure.

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In theory, reduced volatility, if perceived to be persistent, can support higher asset valuations–and lower risk premiums–as investors require less compensation for risks about expected growth and inflation. In this manner, confidence appears to beget confidence, with recent history giving some measure of plausibility to the notion that very bad macroeconomic outcomes can be avoided. The Great Moderation, however, is neither a law of physics nor a guarantee of future outcomes. It is only a description–an ex post explanation of a period of relative prosperity. If policymakers and market participants presume it to be an entitlement, it will almost surely lose favor. In terms of investments, equities as a class are among the most liquid assets.

Market Liquidity

Furthermore, we decompose institutional shareholding by portfolio turnover and nationality and then determine the monitoring channel that influences earnings quality. We find that passive monitoring by domestic blockholders is most effective in improving earnings quality in Korea. In addition, our findings highlight that the difference between the institutional context of developed economies and that of Korea results in different outcomes related to blockholder monitoring. Adrian, T, N Boyarchenko and O Shachar , “Dealer balance sheets and bond liquidity provision”, Federal Reserve Bank of New York Staff Report 803. In its latest monetary report to Congress, the Federal Reserve writes that despite these increased market discussions, a variety of metrics of liquidity in the nominal Treasury market do not indicate notable deteriorations.

Thus the stock for a large multi-national bank will tend to be more liquid than that of a small regional bank. There are a number of ratios that measure accounting liquidity, which differ in how strictly they define «liquid assets.» Analysts and investors use these to identify companies with strong liquidity. Market liquidity refers to the extent to which a market, such as a country’s stock market or a city’s real estate market, allows assets to be bought and sold at stable, transparent prices. In the example above, the market for refrigerators in exchange for rare books is so illiquid that, for all intents and purposes, it does not exist. In other words, liquidity describes the degree to which an asset can be quickly bought or sold in the market at a price reflecting its intrinsic value. Cash is universally considered the most liquid asset because it can most quickly and easily be converted into other assets.

In a market with low activity, a single sale can take a lot longer to complete due to a lack of willing buyers and sellers. Once a transaction has taken place, it can have a much larger impact on the market price to account for the lack of willing participants. When people talk about liquidity, they’re usually either referring to market liquidity or accounting liquidity. If you are trading an overseas market, or a market out of hours, you might find that there are fewer market participants and so the liquidity is much lower. For example, there might be less liquidity on GBP forex pairs during Asian trading hours. If there is volatility on the market, but there are fewer buyers than sellers, it can be more difficult to close your position.

Technology, regulations and liquidity

A stock’s liquidity generally refers to how rapidly shares of a stock can be bought or sold without substantially impacting the stock price. Stocks with low liquidity may be difficult to sell and may cause you to take a bigger loss if you cannot sell the shares when you want to. The most liquid market is cash because it can instantly be converted into other assets.

The importance of stock liquidity on option pricing

This paper investigates the reaction of global equity market sectors to sovereign rating news issued by the three largest credit rating agencies , S&P, Moody’s, and Fitch, during the period 10th August 1994 https://xcritical.com/ until 31st December 2019. Results show significant reactions by equity market sectors to sovereign rating news. This reaction is asymmetric as negative news affects market sectors more than positive news.