Stock Market Liquidity

Liquidity is believed to be a broad and complex concept. In addition, this concept is quite elusive since it is not clearly observable. The definitions of liquidity vary from simple explanations such as “the ease of trading a security” (Amihud, Mendelson, & Pedersen, 2005) to more elaborating descriptions, e.g. “the ability to trade large quantities quickly, at low cost, and without moving the price” (Pastor & Stambaugh, 2003).
The opposite of liquidity notation, illiquidity, has various sources of origin. It may arise, first of all, from trading costs such as brokerage fees and commissions, order-processing costs, or transaction taxes. Asymmetric (private) information could also influence trading activity. For instance, the trading desk personnel

Numerous studies researched this question, however, vast majority of them were based on U.S. data. Therefore, in this thesis we would like to investigate this relationship using the UK market data. The reason for examining the UK data, in particular the stocks traded at the London Stock Exchange (LSE), is because LSE is one of the top 5 biggest stock exchanges in terms of equity market capitalization . This implies a wide range of stocks varying from large-cap to small- and microcap stocks. It is particularly important for our research since some of the academic papers demonstrated that liquidity effect increases from micro- to large-cap

The authour uses this illiquidity measure to regress cross-section of individual stock returns on their prior-year illiquidity measures. The results demonstrate that illiquidity has a positive impact on stock returns. As shown by Florackis et al. (2011), has several apparent advantages. First, the ratio per se is very intuitive hosting the idea that the stronger the response of returns, the less liquid is the stock. Second, this illiquidity ratio is consistent with other theoretical concepts (Kyle (1985), Pastor & Stambaugh (2003)). It is aslo shown in Cochrane (2005a) that the ratio may have a “price discovery” component when the trading is motivated by information that changes expectations about future share price movements. Third, Amihud’s illiquidity measure is reciprocal to the Aminvest ratio that is widely used by professionals. Nevertheless, Florackis et al. (2011) identify the drawbacks of Amihud’s ratio such as a significant size bias meaning that illiquidity ratios cannot be compared across the stocks with various market capitalizations. In addition, the auhtors point to the fact that investors’ holding horizons are neglected by Amihud’s illiquidity ratio.
Hence, it might be concluded that the universe of liquidity proxies is vast. The choice of liquidity measures is mainly conditioned