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Tuesday, September 12, 2006

Resilience of liquidity of the Indian equity and bond markets

One key aspect of market liquidity is the resilience of liquidity. This is not a word that has been sharply defined in the literature; it has a few dimensions. One aspect is the time in which a limit order book restores to having the low impact cost prior to the placement of a large trade. If one could measure this in an experimental setting for a given security, suppose a large order is placed at t=0. Measuring resilience is about obtaining a graph with transaction size on the x axis and the time taken for impact cost to "substantially" revert to conditions that were prevalent at t=0.

Another dimension of liquidity is the ability of market liquidity to handle bad news or negative returns. I don't really understand why, but it often seems that market liquidity is diminished after negative news. One part of this is just a measurement issue : dollar turnover is higher after prices have gone up and lower after prices have gone down. But even if one is using measures of liquidity which are not affected by this problem, the hallmark of a successful financial market is resilience in the sense of being able to handle sharp movements, particularly sharp negative movements, and continue to deliver a continual supply of liquidity. Participants face greater liquidity when this is not the case.

Susan Thomas has an EPW article on the resilience of liquidity on the Indian equity and debt markets. The main finding is that the equity market has considerable resilience while the debt market does not. I think this is related to RBI's belief that the bond market should have no speculators compared with SEBI's belief that speculators are a legitimate part of the equity market.

1 comment:

  1. Hi AJAY,

    A new entrant to your blog by means of economic data search.
    Just wanted to know your views on the rising crude prices and its replicating effect on our contry ; specifically when the prices are not passed on. Though the amount of subsidy burden will ultimately be born by the people one day or other , but may be in other way round in terms of tax .Dont you think that the whole process of running an elephant by cutting rates and exposing to low liquidity in auto laons which was sarted few years back leading to higher auto sales inturn leading to Humugous consumption of crude and environment pitfalls (eventually economists doesn't give a head to it) has lead to a growth but than paying heftily. If you see the price rise in crude and its implication of Arabs getting richer in away , the same money (higher premium)being pumped in the same market.For eg default in subprime being offsetted by selling assets to middle east by citi and ubs. Eventually loses in US being paid by UAE.the assets acquired by UAE may go higher from where they have acquired.It seems US plays smart game in all.



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