ABSTRACT

As the recent financial crisis has made clear, the ability to accurately define, measure and explain financial market liquidity is of great importance to academics and market participants alike. Unfortunately, the majority of extant empirical work relies on measures of liquidity that are somewhat narrow in their focus (e.g. bid-ask spreads). The purpose of this article is to add to the academic understanding of liquidity by providing analysis of those aspects of liquidity which are less well understood. Using order level data from a foreign exchange broking system, we empirically analyze various liquidity measures that include spreads, order book depths and order entry rates. Unlike much previous work in this area, we construct depth measures from across the range of open limit orders, rather than focussing only on quantities available at the best prices. Furthermore, we go on to study the joint determination of our liquidity measures, volatility and transaction activity.