BLM: bidimensional approach to measure liquidity

Abstract

In a continuous trading market, taking efficiency as given, VarIatIOns in liquidity can be measured by simultaneous changes in both immediacy costs and depth. Past theoretical and empirical microstructure literature has been, however, one-dimensional. This paper introduces a liquidity measure called BLM, specially designed for time-series analyses, that captures simultaneous changes in both liquidity dimensions and provides a simple solution to deal with those situations in which the change in immediacy costs and depth does not lead to an unambiguous shift in liquidity. Using data from the NYSE, it is evidenced that this measure captures short-term liquidity dynamics that cannot be captured by one-dimensional proxies of liquidity. This measure is applied to the study of how liquidity reacts to changes in the market conditions. It is shown that only volatility shifts have an unambiguous effect on liquidity independently of the trading hour.