Definition of Liquidity
• Widely Accepted Definition: A liquid market allows participants to quickly conduct a large number of transactions with minimal impact on prices. This means that there are sufficient buy and sell quotes in the market, with a small bid-ask spread, allowing investors to expect to complete transactions at prices close to the average market price over a longer period.
• Black's (1971) Definition: Liquidity is the ability to convert stock assets into cash and vice versa, involving the execution costs of the process of monetization or conversion. A liquid market allows for quicker and lower-cost monetization or conversion.
Measuring Liquidity
• Trading Volume: Liquidity can be measured by the size of trading volume. In a liquid market, the premium (discount) required for conducting transactions of the same scale is smaller.
• Price Volatility: In a liquid market, the impact of trades on prices is smaller, and price volatility is not significant.
• Transaction Wait Time: In a liquid market, completing a transaction usually requires a shorter wait time.
