MECHANICS OF LIQUIDITY SUPPLY AND DEMAND IN ASIAN MARKETS

Abstract

In view of the recent upheaval in financial markets, the interaction between market returns and stock liquidity deserves careful analysis. Liquidity dry-ups may be due to the demand effects, such as panic selling started by the investors in the market, the supply effects, such as withdrawal of market making by financial intermediaries, or both. Although intellectually speaking, the demand effects and the supply effects differ conspicuously, they are extremely hard to be distinguished from empirical evidence. The reason is that the positions of different market participants and financial intermediaries are not known. In this paper, negative correlation between changes in liquidity and changes in market and idiosyncratic returns has been established for equity markets in Singapore and China. However, the relationships between liquidity and negative returns are ambiguous and only have marginal effects. The asymmetric effect of changes in return on liquidity that is documented for US markets, is not found. The changes of liquidity for individual stocks are largely explained by the aggregate changes of liquidity at the market level. It is observed that the commonality in liquidity seems to increase during liquidity crisis. Finally, the changes in both liquidity level and liquidity commonality are positively associated with the changes in volatilities.