Quantitative Finance Stack Exchange is a question and answer site for finance professionals and academics. It only takes a minute to sign up.
Sign up to join this community
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?
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.
I would consider Amihud (2002) as a good first approximation with that level of data.
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.
