Liquidity on the Indian stock market1996 versus 2002

Susan Thomas

http://www.igidr.ac.in/˜susant

susant@mayin.org

IGIDR

Bombay

Liquidity on the Indian stock market – p. 1/17

“We all know liquidity when we seeit”

Liquidity is the ability to do large transactions, quickly,at low transactions costs.

Depth How big a transaction can I do without affectingthe price?

Tightness What is the difference between buy and sellprices?

Resilience How quickly does the market bounce back?

The focus of the literature has become on measurementof transactions costs. High liquidity is low transactionscosts.

Liquidity on the Indian stock market – p. 2/17

Measurement is hard

This talk is all about measurement. There are quite afew issues.

Market transparency and disclosure rules are a hugeproblem.

OTC markets: Information problems.Exchange market: Exchange has to take efforton disclosure.Examples: NSE and order book snapshots; NSEand TAQ.

Liquidity on the Indian stock market – p. 3/17

I. Trading volume

Easy to measure.

Does not measure transactions costs.

Easy to fake.

Bigger stocks will innately have higher turnover.

Liquidity on the Indian stock market – p. 4/17

II. Turnover ratio

365 days volume, divided by today’s market cap.

Rescale turnover so as to control for size.

All the same problems as volume.

Perhaps the most widely used, mostwidely-comparable liquidity measure.

Liquidity on the Indian stock market – p. 5/17

III. Trading intensity

Number of trades per minute.

Does not measure transactions costs.

In India, when market lot went to 1, the number oftrades went up.

Liquidity on the Indian stock market – p. 6/17

IV. Average trade size

Does not measure transactions costs.

In India, when market lot went to 1, average tradesize collapsed.

Liquidity on the Indian stock market – p. 7/17

The limit order book

Access to information in the LOB has been abreakthrough for liquidity measurement.

Can accurately price the “impact cost” faced indoing a market order.

NSE releases 4 ‘snapshots’ of the order book everyday.

Liquidity on the Indian stock market – p. 8/17

V. Impact cost

Suppose we face bid/offer of 99/101.

We define “the ideal price” as (99+101)/2 = 100.

Suppose a transaction for 1000 shares goes throughat Rs.102.

We say “the impact cost for doing 1000 shares is2%”.

This is squarely about transactions costs.A speculator who buys 1000 shares, and then sellsthem off, using market orders both ways, spends 4%.

Impact cost depends on transaction size.

Liquidity on the Indian stock market – p. 9/17

IC is for (a) a timepoint and (b) atransaction size

-2 0 2

Quantity (Rs 10 million)

-0.5

0.0

0.5

Impa

ct C

ost(

%)

Liquidity Supply Schedules of INFOSYSTCH.

Date: 20020301 Time: 11 am

Liquidity on the Indian stock market – p. 10/17

1996 versus 2002

In 1996, we had NSE and we had electronic trading.

But everything else happened after 1996: clearingcorporation, depository, elimination of badla, rollingsettlement, EFT, derivatives trading.

1996 was before the IT boom; 2002 was after.

What happened to liquidity?

Liquidity on the Indian stock market – p. 11/17

Log trading volume

0

0.05

0.1

0.15

0.2

0 2 4 6 8 10 12 14 16 18 20 22

Den

sity

Log (Traded volumes)

Average traded volumes

1996; 1451 scrips2002; 951 scrips

Liquidity on the Indian stock market – p. 12/17

Turnover ratios

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

-6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6

Den

sity

Log (turnover ratio)

Turnover ratios

11.3% scrips with TR > 1

4.51% scrips with TR > 1

TR > 1 19962002

Liquidity on the Indian stock market – p. 13/17

Number of trades

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0 2 4 6 8 10 12

Den

sitie

s

Log(Average no. of trades)

Average no. of trades

19962002

Liquidity on the Indian stock market – p. 14/17

Mean trade size

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

6 8 10 12 14 16

Den

sitie

s

Log (Trade size)

Average trade size

19962002

Liquidity on the Indian stock market – p. 15/17

Impact cost

0

0.05

0.1

0.15

0.2

0.25

0.3

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Den

sity

Impact cost (%) at transaction size of Rs.10000

Median Impact Cost

19962002

Liquidity on the Indian stock market – p. 16/17

Conclusion

Overall, turnover has done well.

But impact cost has not improved.

This merits further investigation.

One possibility: The nature of firms in 1996 aredifferent from the nature of firms in 2002.

Liquidity on the Indian stock market – p. 17/17