Determinants of liquidity in open electronic limit order book market

Abstract

In the last decade, many emerging capital markets have undergone drastic changes in terms of market microstructure changes, specifically in secondary markets. One of the policy concerns is the improvement of liquidity in markets. We study the various determinants of liquidity with reference to Indian stock market. There is no consensus on the proxies of liquidity in the financial markets. We calculate impact cost as the proxy for liquidity. It captures the trade size information as well as price information. It is better than highly popular proxy, bid-ask spread, as it provides information beyond the inside quotes. We estimate the fixed effect panel data model to analyse the variation in level as well as volatility of liquidity. We show that 58% of the cross sectional and time series variation is captured by adverse selection risk proxies, inventory risk proxies, and time dummies. Even after controlling the firm specific factors, we still observe the annual and monthly systematic pattern in the liquidity in emerging stock markets.