Tuesday, October 18, 2011

Stock market liquidity and volatility.

Felix Salmon asks "should we be worried about stock market liquidity?".  He cites a Wall Street Journal article that claims that as volatility increases liquidity decreases.   Felix correctly recognizes that this isn't really anything to worry about.  In fact the positive relation between spreads and volatility is very well documented (even in my own work - see table 5).

The question then seems to relate to high frequency trading and whether algorithmic trading is perhaps eating up liquidity.  Recent academic work in this area provides evidence that this is not the case.

Finally Felix notes that a investor who was trying to buy a $250 Million chunk of a $4 Billion company was apparently surprised when his buying pushed up the stock price.  Again, this is to be expected when you are trying to buy a 6%+ stake in a company.

I agree with Felix here - there really doesn't seem to be much of a story - despite what the WSJ thinks.