Everyone seems to be worried about market liquidity – the ability to buy or sell a large quantity of an asset with little or no price impact. Some observers complain that post-crisis financial regulation has reduced market liquidity by forcing traditional market makers – say, in corporate bonds – to withdraw. Others focus on episodes of sudden, unforeseen loss of liquidity – for example, in the equity and Treasury markets – suggesting that structural changes (such as the spread of high-frequency algorithmic trading) are now a source of fragility. We’ve written about these issues before (here and here).
But it is worth taking a step back to ask exactly what it is that we care about. The answer turns out to be complex, so working out remedies will be a big challenge...Read More