Measuring Treasury Market Liquidity
by Michael J. Fleming of the Federal Reserve Bank of New York
Abstract: Securities liquidity is important to those who transact in markets, those who monitor market conditions, and those who analyze market developments. This article estimates and evaluates a comprehensive set of liquidity measures for the U.S. Treasury securities market. The author finds that the commonly used bid-ask spread-the difference between bid and offer prices-is a useful measure for assessing and tracking liquidity. The spread is highly correlated with a more sophisticated price impact measure and is correlated with episodes of reported poor liquidity in the expected manner. He also finds that other measures correlate less strongly with episodes of poor liquidity and with the bid-ask spread and price impact measures, indicating that they are only modest proxies for market liquidity. Trading volume and trading frequency, in particular, are found to be weak proxies for market liquidity, as both high and low levels of trading activity are associated with periods of poor liquidity.
Published in: FRBNY Economic Policy Review, Vol. 9, No. 3, (September 2003), pp. 83-108.