Why Is Liquidity So Important in Commodities?

As of late 2016, average bid-ask spreads for benchmark notes in the interdealer market were narrow and stable – and comparable to pre-crisis levels, as shown in Figure 4 below. The evolution of the price impact of trades, shown in Adrian et al , similarly suggests a modest deterioration in liquidity since early 2013. They may argue that any excess liquidity in financial markets results from too little capital investment, here and abroad, which may arise from a lack of confidence in future economic outcomes. For example, high cash balances at U.S. corporations can be interpreted as indicating a lack of confidence in investment prospects.

Market liquidity

Accounting liquidity measures the ease with which an individual or company can meet their financial obligations with the liquid assets available to them—the ability to pay off debts as they come due. As a result, bid-offer spreads have widened to their highest in years for capital-intensive, off-the-run securities. Meanwhile, market depth—the amount that can be traded without moving the market—has fallen by 65%–85%, depending on maturity . When COVID-19-related shutdowns initially took hold in early 2020, the Treasury market experienced short-term trading frictions. In a possible prelude to a longer-term solution, the Fed temporarily exempted government debt and central-bank reserves from these reserve requirements, known as the supplementary reserve ratio .


Table 7 displays the regression results with random effects from Models (10–12) that examine the performance of large-cap and small-cap stocks of Vietnam-listed banking, finance and insurance companies. During the COVID-19 surges, large-cap stocks have a notable impact in terms of returns as compared to small-caps. This means firms with smaller market capitalization tend to yield lower returns than those with higher market cap amid the pandemic outbreak in Vietnam, which is against Al-Awadhi et al. .

It exhibits higher correlation with spread and price impact than other existing low-frequency liquidity measures in most of our sample markets. The improvement gained from using our AdjILLIQ measure is particularly significant in inactively-traded markets and low-turnover stocks. We find that the liquidity in emerging markets, as measured by AdjILLIQ, can be improved by better disclosure and less information asymmetry. Furthermore, the liquidity dry-up during market downturns can also be alleviated by better information environment. The seemingly unrelated problems of stock market liquidity and manager-stockholder contracting are closely intertwined. Active stockholders who reduce agency costs by providing internal monitoring also reduce stock liquidity by creating information asymmetry problems.

Liquidity exists when investors are confident in their ability to transact and where risks are quantifiable. When considered in terms of confidence, liquidity conditions can be assessed through the risk premiums on financial assets and the magnitude of capital flows. Investors’ confidence in risk measures is greater when the perceived quantity and variance of risks are low. In recent quarters, we witnessed very strong credit markets, bulging pipelines for leveraged loan and high-yield bond issuance, and near-record low credit spreads. Structured fixed-income products proliferated, and the investor universe expanded to match new supply. Global investment flows were proven noteworthy for the lack of home-country bias.


For investors, liquidity is a risk factor, much like interest-rate risk and credit risk. Shifts in market dynamics can create investment opportunities in less-trafficked parts of the Treasury yield curve, or in related markets and financial instruments. Given the proper framework for managing risk, market dislocations can result in compelling investment opportunities. While inflation remains elevated in stickier categories, Fed policy may be having an impact. Lower inflation and less economic uncertainty could reduce volatility in the bond market and increase market depth—improving liquidity in the process. As the Fed and other large, developed-market central banks approach peak forecasted interest rates, it’s not unreasonable to believe that bond-market conditions could improve.

It is worth noting that the regression coefficients of all dummy variables for D_LOCK_J are positive and significant at 1% or 5% level. The result indicates a positive impact of the lockdown measures on stock returns of the banking, finance and insurance companies listed on Vietnam's stock exchanges, which is also consistent with past research of Anh and Gan . One of the reasons for this is an increase in investor confidence toward the Government's well-organized pandemic control programs and policies. Regarding company-related characteristics, under the impact of the COVID-19 pandemic, market capitalization has a significant and positive correlation to stock returns.

An asset that can be sold rapidly for its full value is said to be highly liquid. An asset that takes significant time to sell, or one that can only be sold at a discounted value, is considered less liquid or illiquid. Adrian, T, M Fleming, E Vogt and Z Wojtowicz , “Did Third Avenue’s liquidation reduce corporate bond how to find liquidity provider?

Market Liquidity

Notwithstanding such contrasting arguments, the results show no difference in market liquidity among firms with varied market capitalization. To date, there exists a considerable amount of studies on the impact of the COVID-19 lockdown on stock returns and market liquidity. It is congruent with research by Baig et al. , which finds that the COVID-19-related lockdown reduces the stability and liquidity of the US stock market. Anh and Gan , however, draw an opposite conclusion when examining the performance of the Vietnam stock market. They argue that the epidemic preventive measures, including lockdown, create a significant positive effect on the stock returns of all businesses.

In this situation you could risk becoming stuck in a losing position or you might have to go to multiple parties, with different prices, just to fill your order. In a liquid market, a seller will quickly find a buyer without having to cut https://xcritical.com/ the price of the asset to make it attractive. And conversely a buyer won’t have to pay an increased amount to secure the asset they want. A liquid asset is an asset that can easily be converted into cash within a short amount of time.

Are Japanese stock prices too high?

For liquid stocks, such as Microsoft or General Electric, the spread is often just a few pennies – much less than 1% of the price. For illiquid stocks, the spread can be much larger, amounting to a few percent of the trading price. One example of this is a comparison of assets with and without a liquid secondary market. The liquidity discount is the reduced promised yield or expected return for such assets, like the difference between newly issued U.S.

Market liquidity

Dealer leverage (assets/equity) has followed a similar path, as seen in Figure 2. Leverage peaked at 47.9 in the first quarter of 2008, around the near-failure of Bear Stearns, and then plunged to just 25.0 in the second quarter of 2009. Leverage remained fairly steady until 2012, but has since trended down, reaching 17.6 in late 2016.

Why Is Liquidity Important?

Likewise, in October 2014, US Treasury yields plummeted by almost 40 basis points in minutes. The latest episode came in May 2015, when, in the space of a few days, ten-year German bond yields went from five basis points to almost 80. These events have fueled fears that, even very deep and liquid markets – such as US stocks and government bonds in the US and Germany – may not be liquid enough.

  • Figure 3, for example, plots the credit default swap -bond basis, calculated as the average difference between each bond's market CDS spread and the theoretical CDS spread implied by the bond yield.
  • Although these are three of the most liquid financial markets, cash is actually the most liquid asset because it can be used to buy just about anything.
  • One way to manage liquidity risk is through the use of guaranteed stops, a type of stop-loss that ensures your position is closed at your pre-selected price level.
  • Trading volume of at least 1 million shares daily is considered a sign of market liquidity.
  • Since the outbreak of the COVID-19 spanning on a global scale, its negative impact on stock returns has prevailed in a bulk of studies.
  • Thank you to the Institute of International Bankers for inviting me to speak about liquidity in U.S. financial markets.

Bloomberg Markets European Open Bloomberg Markets European Open kick starts the trading day, breaking down what's moving markets and why. Francine Lacqua and Tom Mackenzie live from London bring you an action-packed hour of news no investor in Europe can afford to miss. We believe that the extensive business ties between chaebols and blockholders effectively increase the cost of shareholder activism in Korea, making passive monitoring a more applicable governance mechanism for blockholders. We test whether passive monitoring affects a firm’s earnings quality, represented by earnings persistence, value relevance, and timeliness.

Meaning of market liquidity risk in English

The liquidity of markets for other assets, such as derivatives, contracts, currencies, or commodities, often depends on their size, and how many open exchanges exist for them to be traded on. Banking and finance sector plays a vital role in the stock market of most nations including Vietnam. Research by the World Bank has claimed a strong tie between GDP per capita growth and credit growth in Vietnam. By the end of 2019, the market capitalization of the financial services sector was 29.08%, which accounted for the highest share of the total stock market.

This proactive approach briefly stabilized the Treasury market, but SLR exemptions have since lapsed, and large banks are once again forced to make difficult capital-allocation decisions that may or may not include US Treasuries. These regulations have exacerbated liquidity concerns by discouraging large banks from acting as intermediaries for US government debt. As a result, the volume of Treasuries that change hands each day as a percentage of the total market plummeted sharply and has continued to decline . Financial markets have been upended by historically high inflation, soaring interest rates, dissolution in global trade and armed conflict in Ukraine. Forwards and swaps are principal-to-principal, often financially settled instruments. However, they can and do often allow for physical delivery of the commodity asset.

Meanwhile, markets that deal in physical assets are less liquid – such as real estate and fine art – as the sale process takes much longer. When there are high levels of trading activity – meaning there is both supply of, and demand for, the asset in question – individuals will be able to easily complete transactions. Finding someone willing to take the other side of an exchange is easier, so there will be little effect on the market price. Small-cap stocks are not traded as frequently, which means that when there is a demand for their shares, it can have a massive impact on the market and create significant volatility. The most important thing to remember is that market liquidity is not necessarily fixed, it works on a dynamic scale of high liquidity to low liquidity. A market’s position on the spectrum depends on a variety of factors such as the volume of traders and time of day.

Those regulatory reforms include higher bank capital requirements, new leverage ratios, and liquidity requirements. While these regulations are intended to make the US and the global financial system more resilient, some market participants argue that they also hinder market making by raising the cost of capital and restricting dealer risk taking. Robin Wigglesworth writes that scarred by the financial crisis, retail investors gravitated towards the supposed safety of fixed income. But their funds have bought increasingly illiquid bonds while still offering investors the opportunity to pull out whenever they want. If losses spook investors to do that, asset managers will sell bonds in order to pay investors their money back, the type of scenario that can quickly become a fire sale. Commercial and industrial (C&I) lending potential has expanded with the adoption of syndication practices, allowing credit risks to be spread across a greater number of participating banks and nonbank lenders.

On January 1st, 2021, a new, highly infectious variant of the COVID-19 originated from the United Kingdom was discovered in a Vietnamese 45-year-old female patient. By the noon of January 28th, 2021, Hai Duong Province implemented social distancing after 75 community transmission cases being recorded within the day, leading to an end of 55 coronavirus-free days in Vietnam. On April 27th, 2021, a hotel receptionist was diagnosed with the virus as being in close contact with some experts from India, named as 2857th patient.

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