Market Lquidity

In the last post I was focused on the behaviours and states of firms with respect to this measure of liquidity.  In this post I will shift focus to the market for securities. 

With the Coasean definition of the firm clearly in mind, it is important to see the relationship between firms and markets.  Firms are economic spaces where various efficiencies make production inside the firm more worthwhile than sourcing the product directly from the market.  But firms need markets for their survival.  They source materials and funding from marketplaces.  They sell their own products on markets.  They are non market entities in a sea of markets.

But markets themselves aren't actors in the sense in which a firm is an actor.  A firm has projects, has responsibilities, obligations, fiduciary, legal, creditor obligations.  Yet markets themselves can be characterised by measures of liquidity too.  Any given market, at various times, can reasonably be characterised as more or less liquid than it was, or in comparison to other markets.  If is often the case that relative market liquidity is stable enough for there to be a more or less natural ranking of markets in terms of their liquidity. 

So, for example, cash markets are considered usually the most liquid.  This is not an economic axiom, it just usually happens to be the case.  Next there are so-called cash-like markets (certificates of deposit, sovereign bonds and so on)  Each market in isolation can experience moves of liquidity on its own terms, through time.  There is, if you will, a variance on the standalone liquidity of the market.  Each market will have its own long term (normal) liquidity level, and its own variance.  As well as the 'in isolation' metric, each of these markets can be compared to each other to rank them in terms of most to least liquid - this rank order whilst not immutable, is often a stable ranking.  The ranking is a ranking of the mean liquidity.  The variances themselves could be ranked too, as could their volatility of volatility.  All three resulting rankings would be interesting and would probably usually correlate well with each other.

It is, of course, the degree to which this stability breaks down which is often the primary focus of a liquidity analysis.

The collective opinion of market participants is what ultimately drives not only the relative liquidities of the various markets  but also the fate of firms during periods of so-called illiquidity,  since it is bond holders and other creditors through capital markets which can determine the demands on a firm with respect to liquidity.  Clearly many markets are, at any given time, more or less similar to each other (Vodafone and Telecom Italia equity markets, for example are more similar than a Shell dividend swap is to a Japanese asset swap).

In the next posting, I look at what it is about certain markets, what attributes they have which drives this opinion of market participants.