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Market Liquidity: An Elusive Variable

Robert A. Schwartz, Reto Francioni and Peter Weber
The Journal of Portfolio Management September 2020, 46 (8) 7-26; DOI: https://doi.org/10.3905/jpm.2020.1.174
Robert A. Schwartz
is Marvin M. Speiser Professor of Finance and University Distinguished Professor at Baruch College of the City University of New York in New York, NY
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Reto Francioni
is professor of applied capital markets theory at the University of Basel in Basel, Switzerland
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Peter Weber
is with the University of Basel in Basel, Switzerland
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Abstract

Equity prices depend on risk, expected return, and market liquidity. Market liquidity, however, is an elusive variable. Prevailing thinking relates primarily to revealed liquidity (e.g., posted orders). The authors propose the concept of latent liquidity to complement this definition and discuss liquidity in terms of its empirical assessment, dependence on market structure, and effect on asset pricing. Regarding regulatory policy concerning market structure, the objective should be to enhance market quality, which is tantamount to liquidity provision. This should lead to extended economic benefits because one thing is widely agreed on: All financial markets would benefit from being more liquid.

TOPICS: Portfolio theory, portfolio construction, equity portfolio management

Key Findings

  • • The title itself says it: Liquidity is an elusive variable. It is hard to define, measure, and find.

  • • A large and important component of liquidity is latent liquidity: orders that are not posted on a lit book. Consequently, it is not possible to quantify liquidity empirically.

  • • Illiquidity leaves its footprints in the transaction record: accentuated intraday price volatility and return autocorrelation. These are affected by the structural design of a financial market and by market structure regulation.

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The Journal of Portfolio Management: 46 (8)
The Journal of Portfolio Management
Vol. 46, Issue 8
September 2020
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Market Liquidity: An Elusive Variable
Robert A. Schwartz, Reto Francioni, Peter Weber
The Journal of Portfolio Management Aug 2020, 46 (8) 7-26; DOI: 10.3905/jpm.2020.1.174

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Market Liquidity: An Elusive Variable
Robert A. Schwartz, Reto Francioni, Peter Weber
The Journal of Portfolio Management Aug 2020, 46 (8) 7-26; DOI: 10.3905/jpm.2020.1.174
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  • Article
    • Abstract
    • FOUNDATIONS
    • LIQUIDITY IN PRACTICE
    • FORMULATION OF REGULATORY POLICY
    • CONCLUDING REMARKS
    • ACKNOWLEDGMENTS
    • ADDITIONAL READING
    • ENDNOTES
    • REFERENCES
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