The Value of Liquidity

Abstract

This article presents a framework for quantifying the value of liquidity. The authors suggest that liquidity is valuable from both cost and risk perspectives. The value of liquidity from a cost perspective may be quantified by using a cost model to compare an estimate of the market impact expected by executing an alternative trading strategy with the market impact of interacting with unexpected liquidity. The value of liquidity from a risk perspective may be quantified by using a risk model to compare the risk exposure expected to be incurred by executing an alternative trading strategy with the risk exposure expected to be incurred by interacting with unexpected liquidity.