An Unusual Warning From Goldman Sachs: “Market Depth Has Collapsed”
by Tyler Durden
ZeroHedge.com
Mon, 07/23/2018
With Morgan Stanley becoming the latest to join the growing lament over the market’s ever declining liquidity, noting that “It’s Not Your Imagination, Large Moves Are Becoming More Common In The Market” an appropriate question that has emerged is just how does one define, and measure, liquidity?
Today, Goldman’s derivatives strategist Rocky Fishman shares his answers, with a particular emphasis on market top-of-book depth which has implications on both bid/ask spreads and ease – and cost – of execution:
Liquidity is both hard to define and hard to monitor. Volumes, bid/ask widths, and ease of execution can all be metrics of liquidity. A key (unmeasurable) metric is the ease of executing a large trade – for example, what would the market impact of selling $1bln of SPX futures be? Of utmost importance to hedgers and volatility traders is an even more unmeasurable number: what would the market impact of a large order be if markets are already down several percent in a day? It is hard not to see the material deterioration in top-of-book depth as having negative implications for this last metric of liquidity as well.
Fishman then introduces a novel concept: an uncertainty principle when it comes to measuring liquidity, which leads him to observe that “liquidity can be monitored but not measured”:
Liquidity is unmeasurable: when defined as the ease (or cost) of executing a large trade, the only true way to measure liquidity is to actually trade large amounts, but that act would in itself alter liquidity conditions (liquidity’s Heisenberg uncertainty principle?). Barring a true measurement of liquidity, there are various metrics we watch to monitor liquidity. Volume is one: markets exhibiting high volume are generally more liquid than those exhibiting low volume. However, volume can be misleading in times of market stress, because a rush to re-align portfolios may push up volume even with high trading costs.
The Rest…HERE
