Likviditet och marknader

Liquidity and markets

It is useful to distinguish between different forms of financial market: markets for liquidity and markets for speculation. Of course, this is a simplification in that most markets lie on a spectrum between these extremes. The London unsecured deposit market is a prime example of a market for liquidity and, indeed, government securities markets are predominantly markets for liquidity.

By contrast, some other markets may have little or novalue to, or participation in, by institutions hoarding liquidity. The derivatives markets are almost entirely markets for speculation; indeed the absence of a role as a liquidity store is evident from the fact that a fairly priced derivative such as an interest rate swap will have no exchange of money or liquidity at contract inception. Note that hedging is a form of speculation; the contract serves its purpose by change of price rather than any inherent productive return. It is an inside contract; this is a zero-sum game between participants in the private sector. It is concerned only with the distribution of risk and return within private sector participants.

Figure 1: Decomposition of corporate bond yield spreads. (Bank of England)

Equity markets are mixed in nature: long-term investors buy assets in these markets to harvest their productive returns rather than with gain in market price in mind. For this investor class of participant, which of course includes pension funds, volatility of market price is unconditionally bad. By contrast, there is the speculative class of market participant, such as a hedger, where the security is purchased for its price potential, and for these speculator participants, volatility is welcome since its enlarges their opportunity set. This conflict between speculators and investors lies at the heart of the debate over high-frequency trading.

In markets for liquidity information asymmetry is extremely harmful, as is any substantial sensitivity of prices to information. Some other markets, such as those for speculation, may thrive upon information uncertainty.

The decomposition of the liquidity term from other influences in market prices is a non-trivial exercise. The nature of this problem may be illustrated by an analysis of nominal corporate bond yield spreads, which is recurrently published by the Bank of England.

In the case of equities, the problem is compounded as both the implicit discount rate and future dividend cash-flows are not observable. As pension funds move to a balance sheet and financial risk management view of the world, they will inevitably come to increase their exposures to markets for speculation, rather than investment, and that will have negative consequences for their long-term investment performance.

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