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Measuring bond market liquidity: devising a composite aggregate liquidity score

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  • Moorad Choudhry

Abstract

The importance of liquidity in financial markets is emphasized strongly in the academic literature. There is no single definition of liquidity, which can lead to confusion when attempting to measure liquidity levels. This problem is often solved through the use of proxy indicators such as the bid offer spread. No single measure is completely satisfactory, and the use of proxy measures renders comparison across markets difficult. Our objective is to devise a composite aggregate measure of liquidity that makes use of a range of market factors, and which is applicable to any financial market. For illustration, we consider the UK government bond market during 1993-2002, a period during which structural reform aimed at improving liquidity was undertaken. We devise a transparent, accessible and easy-to-implement method to measure liquidity level in a financial market, using an aggregate scoring system. This adopts a composite methodology, using components selected on the basis of their relative importance to promoting liquidity. Our measure suggests that market liquidity improved in the gilt market our observation period. Furthermore, the measurement methodology we propose may be employed as a practical tool by institutional investors to measure liquidity in any financial market, and enables them to make comparisons across different markets prior to making the investment decision.

Suggested Citation

  • Moorad Choudhry, 2010. "Measuring bond market liquidity: devising a composite aggregate liquidity score," Applied Financial Economics, Taylor & Francis Journals, vol. 20(12), pages 955-973.
    • Handle: RePEc:taf:apfiec:v:20:y:2010:i:12:p:955-973
    DOI: 10.1080/09603101003724281
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    References listed on IDEAS

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    1. Fleming, Michael J, 2002. "Are Larger Treasury Issues More Liquid? Evidence from Bill Reopenings," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(3), pages 707-735, August.
    2. Robert F. Engle & Joe Lange, 1997. "Measuring, Forecasting and Explaining Time Varying Liquidity in the Stock Market," NBER Working Papers 6129, National Bureau of Economic Research, Inc.
    3. Torben G. Andersen & Tim Bollerslev & Francis X. Diebold & Paul Labys, 1999. "The Distribution of Exchange Rate Volatility," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-059, New York University, Leonard N. Stern School of Business-.
    4. Sugato Chakravarty & Asani Sarkar, 1999. "Liquidity in U.S. fixed income markets: a comparison of the bid-ask spread in corporate, government and municipal bond markets," Staff Reports 73, Federal Reserve Bank of New York.
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    Cited by:

    1. Forget M Kapingura, 2015. "Macroeconomic Determinants of Liquidity of the Bond Market in Africa: Case Study of South Africa," Journal of Economics and Behavioral Studies, AMH International, vol. 7(3), pages 88-103.

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