15th Sep, 2015

Institute for Advanced Study

Question

Asked 5th Feb, 2015

How do you measure money and liquidity in a financial market?

If you are looking for liquidity in financial markets and its impact and by financial markets I presume you mean stock markets primarily, I have published some research which have contingent convergence properties to Arrow-Debreu type of money metric equilibrium, following stochastic Borel-Cantelli theorems dependant on interest elasticity of stock demand., dependant on interest cost of companies and dividend distributed per share indexed by specific industries or portfolios. You will find these published papers as mathematical-statistical pricing....... and testing for Pareto Optimality...... on my RG page, if you would like to take a look. SKM QC

1 Recommendation

Direct measurement of liquidity/illiquidity, bid/ask spreads, other trading costs, etc. is difficult and even impossible as intraday trading data are not available free of charge in the case of most emerging stock markets. Given the uncertainty surrounding liquidity estimation, some liquidity/illiquidity measures are especially often advocated in the literature to provide empirical research in liquidity/illiquidity effects in emerging markets.

The popular measures of trading activity, i.e. volume, dollar trading volume, and share or market turnover, are the simplest measures of liquidity.

Lesmond et al. (1999) introduced two simple, but useful measures of illiquidity, which may be denoted as ZERO1 and ZERO2. Furthermore, Lesmond et al. (1999) developed a new liquidity estimator, known in the literature under the acronym LOT.

Amihud (2002) developed a illiquidity measure that captured daily price response associated with one dollar of trading volume.

For example, more details concerning the references are presented in my recent paper:

‘Is illiquidity risk priced? The case of the Polish medium-size emerging stock market’

Best Regards,

Joanna Olbrys

4 Recommendations

Direct measurement of liquidity/illiquidity, bid/ask spreads, other trading costs, etc. is difficult and even impossible as intraday trading data are not available free of charge in the case of most emerging stock markets. Given the uncertainty surrounding liquidity estimation, some liquidity/illiquidity measures are especially often advocated in the literature to provide empirical research in liquidity/illiquidity effects in emerging markets.

The popular measures of trading activity, i.e. volume, dollar trading volume, and share or market turnover, are the simplest measures of liquidity.

Lesmond et al. (1999) introduced two simple, but useful measures of illiquidity, which may be denoted as ZERO1 and ZERO2. Furthermore, Lesmond et al. (1999) developed a new liquidity estimator, known in the literature under the acronym LOT.

Amihud (2002) developed a illiquidity measure that captured daily price response associated with one dollar of trading volume.

For example, more details concerning the references are presented in my recent paper:

‘Is illiquidity risk priced? The case of the Polish medium-size emerging stock market’

Best Regards,

Joanna Olbrys

4 Recommendations

To what my colleagues pointed out above, I will add that since you are measuring the the liquidity on the whole market, the Turnover ratio is one of the most useful liquidity measures; you must, however, use the Trading Volume (In Dollars, rather than number of shares) divided by the market capitalization of the whole stock market. Additional firm-specific measures may not be appropriate in a macro study approach.

Deleted profile

You may find the following paper by Bekaert, Harvey, and Lundblad to be helpful. The title is "Liquidity and Expected Returns: Lessons from Emerging Markets". From the paper's abstract: "Our main liquidity measure is a transformation of the proportion of zero daily firm returns, averaged over the month. We find that our liquidity measures significantly predict future returns, whereas alternative measures such as turnover do not. "

1 Recommendation

The usual measures of liquidity are the size or volume of the means of payment, which start from the monetary base, going through the more liquid financial assets (money in public power and account deposits - that is to say, money or absolute liquidity), to the more illiquid financial assets (M4 or M5, depending on development level of the economy).

Central Bank controls these variables when doing monetary policy, i. e., the public policy that deals with keeping the liquidity level in the economy.

For example, when Central Bank moves the interest rate, it is trying to change the liquidity between the means of payment and, thereby, between financial and real assets.

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