Market liquidity is essential for smooth trading activities from "summary" of Financial Markets and Institutions, Global Edition by Frederic S. Mishkin,Stanley G. Eakins
Market liquidity refers to the ease with which assets can be bought or sold in the market without causing a significant change in their price. It is a crucial factor in ensuring smooth trading activities in financial markets. When markets are liquid, investors can quickly and easily buy or sell assets, which helps to ensure that prices are fair and reflect the true value of the assets. The presence of market liquidity also helps to reduce transaction costs, as investors do not have to worry about large price movements when buying or selling assets. This can encourage more trading activity and increase market efficiency. In illiquid markets, on the other hand, investors may have difficulty buying or selling assets, which can lead to wide bid-ask spreads and higher transaction costs. Market liquidity is particularly important during times of market stress or uncertainty. In times of crisis, investors may be more eager to sell their assets, leading to a sharp decline in prices. If markets are illiquid, this can exacerbate the situation, as investors may not be able to find buyers for their assets at reasonable prices. This can lead to a vicious cycle of declining prices and further reductions in liquidity.- Regulators and market participants can take steps to increase transparency, reduce trading costs, and promote market-making activities. By enhancing liquidity, financial markets can operate more smoothly and efficiently, allowing investors to trade assets more easily and at fair prices. Ultimately, market liquidity plays a crucial role in ensuring the proper functioning of financial markets and supporting economic growth.
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