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I am a developer rather than a quant. I need to decide whether a given equity passes some basic liquidity threshold.

It doesn't have to be precise, just good enough. I have a Bloomberg terminal data feed access (e.g. can get PX_LAST, VOLUME etc.).

Someone suggested using average volume multiplied by the price. Is this a good idea?

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You can use refined methodologies but if you just need a rough estimation of liquidity, you can simply use an average of daily volume over N days. In practice, for equities, people tend to use N = 20 or 30.

Once you have the average daily volume (say 100,000 shares), you compare it to your holding (say 50,000 shares) to determine the the size of your position (in my example: 0.5 days of volume).

It is important to decide which volume to use (primary exchange vs. all exchange volume - on some securities the latter can be 2x or 3x the former).

You can then qualify the liquidity of the holding by making an assumption on the % of volume you think you can trade without impacting prices too much. 20-25% is typical although some argue that for larger positions 15% is already disruptive.

Let's say you think you can use 25% of the daily volume, in my previous example, you would conclude that it would take ca. 2 days to liquidate the position. Or put another way that you would be able to liquidate about 50% of the position in one day.

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  • $\begingroup$ Thank you. I have two further related questions, if you don't mind: 1. How useful is bid-ask spread for checking liquidity? 2. Is it possible to apply your suggestion to compare stocks' liquidity without having/planning a specific position? E.g. how do I compare liquidity of APPL to MSFT to GOOG without considering a specific trade? The reason I ask is that I am trying to decide whether a stock is "good" or "bad" to begin with. $\endgroup$ – Den Aug 21 '15 at 10:16
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    $\begingroup$ @Den 1. bid-ask spread is another measure of liquidity but you can have stocks with tight spreads that trade less $ a day that stocks with wider spread - if your goal is to decide how much you can trade, bid/ask won't help much, if your goal is to decide if an algo with be profitable then bid/ask spread may be very relevant. 2. yes of course. $\endgroup$ – assylias Aug 21 '15 at 11:13
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I would consider Amihud (2002) as a good first approximation with that level of data.

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I think one of the main liquidity measures is the one from Pastor and Stambaugh (2003).

You can use it for both individual stocks or indexes.

Just run the following intra-month regression with daily data:

$r^e_{i,d+1,t} = \theta_{i,t}+\phi_{i,t}r_{i,d,t}+\gamma_{i,t}sign(r^e_{i,d,t}) \times v_{i,d,t}+\epsilon_{i,d+1,t}$.

Where $r^e_{i,d+1,t}$ is the excess stock return of stock $i$ at day $d+1$ of month $t$ and $v_{i,d,t}$ the dollar volume for stock $i$ on day $d$ in month $t$.

Check equation (1) of the paper for further details.

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