Liquidityis the capacity that the market gives to an individual/agent to buy/sell assets at a given price in a short length of time between the initial order and the operation close. This delta in time should be zero for a high liquidity market, and the buy/sell price should be the initial one.
Another measure for liquidity can be the inverse distance (in terms of time) for a generic asset to become money.
This market capacity depends on regulations that define the market microstructure. Indeed, the process that completes the exchange is important in defining how from the bid/ask in the book value the market defines the close price.
Liquidity also depends on the market structure. In a competitive market, liquidity is different from markets where agents or assets are limited or subject to limitations. Market depth is closely related to liquidity.
One common way to define market liquidity is the difference between the bid price and the asking price in the book value. The higher this difference, the lower the liquidity in the market. This happens because it is not easy to match the buy side to the sell side at a particular price in a short period of time. This leads to a situation where both sides of the market need to modify the price in order to settle the exchange. This mechanism is iterated up to the point where the two prices have a zero difference. The shorter the length of time for this iterated mechanism, the higher the liquidity in the market. In this sense, it represents a proxy to measure liquidity.
Liquidity is also determined by the law of asset pricing of the existing microstructure on the basis of the existing economic conditions. A market can be liquid in a certain period of time and non-liquid in others.
O’HARA M., 1997, Market Microstructure Theory, Blackwell, Oxford, UK;
GROSSMAN S. J. and STIGLITZ J. E., 1990, Informazione e sistemi di prezzi concorrenziali, in Informazione e teoria economica, E. Saltari, a cura di, Il Mulino, Bologna.
Editor: Rocco CICIRETTI
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