WP/02/232 IMF Working Paper Measuring Liquidity in Financial Markets Abdourahmane Sarr and Tonny Lybek INTERNATIONAL MONETARY FUND© 2002 International Monetary Fund we 102/232 AMF Working Paper Monetary and Exchange Affairs Department Measuring Liquidity in Financial Markets Prepared by Abdourahmane Sarr and Tonny Lybek’ Authorized for distribution by Ame B. Petersen Deceraber 2002 Abstract “The views oxprossol inthis Working Paper are thove of the walhon(s) and do not necessarily represent those of the IMF or IMF policy. Werking Papers deseribe esearch in progress by the author(s) and are published to elicit comments and to futher debate This paper provides an overview of indicators that can be used to illustrate and analyze liquidity developments in financial markets. The measures include bid-ask spreads, turnover ratios, and price impact measures. They gauge different aspects of market liquidity, namely tightness (costs), immediacy, depth, breadth, and resiliency. These measures are applied in selected foreign exchange, money, and capital markets to illustrate their operational usefulness. A number of measures must be considered because there is no single theoretically correct and universally accepted measure to determine a market's degree of liquidity and because market-specific factors and peculiarities must be considered. JEL Classification Numbers: G1 and G15 Keywords: Measuring liquidity, financial markets Authors’ E-Mail Addresses: asarr@imf org; -lybek@imf.o1 ' Comments by Kai F. Barvell, Steen Byskov, Peter Dattels, Jennifer Elliott, Robert P. Flood, Mats E. W. Filipsson, Shyamala Gopinath, Peter Hayward, Lars Jessen, Jeppe F. Ladekarl, Gabriel Sensenbrenner, Quynh Anh Thai, Hung Q. Tran, and Mark Zelmer on a previous draft, as well as research assistance by Zeyneb Kantur, Hanan Morsy, and Plamen Yossifov are gratefully acknowledged.Contents Page 1. Introduction... 4 UL Selected Liquidity Measures . 8 ‘A. Transaction Cost Measures ... 9 B, Volume-Based Measures... 11 C. Price-Based Measures .... 14 D. Market-Impact Measures. W Other econometric techniques “18 TIL. Application of Liquidity Measures .. A. Poreign Exchange Markets. B. Money Markets . C, Bond Markets. D. Equity Markets... IV. Factors Affecting Asset and Market Liquidity... sentence 36 YV. Liquidity During Periods of Str088......001:esmnnnnennssnnnnncnnennnnnnnes 40 VI. Conclusion... wl References... 60 Text Tables 1. Average Bid-Offer Spreads of Spot and Forwards, October 11, 2001...» 2 2. Bid-Ask Spreads (basis points): Foreign Exchange Markets 3, Market Efficiency Coefficients: Foreign Exchange Markets. 4, Bid-Ask Spreads: Money Markets... 5. Market Efficiency Coefficients: Money Markets... . 6. Selected Liquidity Indicators for Government Securities Markets in G-10 Countries... 32 7. Bid-Ask Spreads (Percent): Bond Markets. 8. Market Efficiency Coefficients: Bond Markets, 9. Liquidity Measures: Equity Markets........ 10. Market Efficiency Coefficients: Equity Markels.. Figures 1. Global Foreign Exchange Market Tumover, 1989-2001...