The characteristics of market liquidity, accoridng to Kyle, are tightness of the market, depth of the marekt and resiliency of prices. By referring to tightness, it descriebes the cost of turning around a position over a short period of time. Does this mean the cost to change your position in a risky security from short to long in the short term? The depth reflect the size of an order flow inovvation required to change prices a given amount, and this means the order flow necessary to induce prices to rise or fall by $1\$$. But what is the intuition behind resilienc of the market? It confuses me a little in the way Kyle sets this.

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    $\begingroup$ An empirical measure of "tightness" could be the bid-ask spread posted by market makers. It's the cost of turning around a position---e.g. buying and then selling. $\endgroup$ – Michael May 24 '20 at 7:32
  • $\begingroup$ Silly question, but does this meand the opposite also? Namely, does this mean selling and then buying? $\endgroup$ – Hunger Learn May 24 '20 at 8:53
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    $\begingroup$ Yes, it's the cost of a round-trip trade, taking and then closing a position. $\endgroup$ – Michael May 25 '20 at 1:04

Each of the aspects mentioned by Kyle points to a useful definition of "liquidity."

Tightness of the market refers to the bid-ask spread, the price difference between the highest bid price across all venues and the lowest offer price across all venues. Theory by Black (1971) suggests that the size at the inside bid and offer will, however, be small. So this measure of liquidity is useful for a small order or a a baseline for larger orders.

Depth of the market refers to the rate at which size cumulates if you add orders sizes moving away from the bid-ask spread. We often model this by thinking first about the slope of those cumulated sizes. If a market has a lot of depth, we can trade large orders and will not need to pay much beyond the bid-ask spread.

Resiliency of prices refers to the rate at which the order book refills. If you were to exhaust the inside bid or ask (or even a few price levels beyond that), resilience measures how quickly those levels will refill with new orders.

For more on these ideas, I would suggest reading up on market microstructure. Hasbrouck's Empirical Market Microstructure is very good as is Foucault, Pagano, and Röell's Market Liquidity: Theory, Evidence, and Policy.


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