Liquidity Black Holes

Avinash Persaud

The Gresham and Mercer Memorial Professor of Commerce

Managing Director & Head of Research

State Street Global Markets

April 2002

What is liquidity and why does it 

matter?

•

Speed, ease and cost of transacting

•

Recorded spreads are a poor measure

•

Poor liquidity is associated with volatility

Price impact of trading

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

Jul-97

Mar-98

Nov-98

Jul-99

Mar-00

Nov-00

Jul-01

Mar-02

Emerging Market Sells

Emerging Market Buys

% return per basis point of market 

•

Big price-impact = low 
liquidity

•

Liquidity is not one 
number

•

Liquidity is variable and 
this matters

Liquidity Black Holes

0

10

20

30

40

50

60

78

 Q

1

79

 Q

1

80

 Q

1

81

 Q

1

82

 Q

1

83

 Q

1

84

 Q

1

85

 Q

1

86

 Q

1

87

 Q

1

88

 Q

1

89

 Q

1

90

 Q

1

91

 Q

1

92

 Q

1

93

 Q

1

94

 Q

1

95

 Q

1

96

 Q

1

97

 Q

1

98

 Q

1

99

 Q

1

00

 Q

1

01

 Q

1

5 year smoothed average

Number of days

Liquidity black holes: number of days per quarter that the 

US, Japanese and UK broad stock indices have moved by 2 

standard deviations more than the average daily price move

•

There are episodes in 
which liquidity disappears 
and then returns

•

Liquidity black holes are 
becoming more frequent

•

Some markets are getting 
bigger and yet thinner

Liquidity needs diversity

•

There is less diversity because

–

Information costs have fallen

–

Less diversity within and between firms

–

Switch to market-sensitive risk management systems

Liquidity needs losers

•

Regulators are encouraging these trends

•

Defending diversity means accepting losses

•

Financial system needs more freedom

Avoiding liquidity black holes

        Average number of Liquidity Black Holes per quarter

Change from the last bubble 

to the previous

                FTSE 100                      

2.594

4.100

         UK 10 year bond                  

2.784

-1.958

          JP 10 year bond                  

2.986

-2.175

               S&P500                          

3.078

3.133

             Toronto SE                       

3.156

6.092

                Topix                             

3.289

3.783

                $/Yen                            

3.445

3.608

        US 10 year bond                   

3.580

-1.667

                 $/CHF                           

3.742

-2.575

                  $/£                             

3.766

-5.500

              Euro/$                       

3.898

-0.950

Conclusion

•

Liquidity black holes matter

•

Liquidity needs diversity and losers

•

Different asset classes have distinctive liquidity 
trends