Unpack key topics that impact banking, investing, financial services and the wider economy in this award-winning explainer series.
Narrator: All assets have a value, but some are easier to sell than others. Say you want to sell your house. It might be worth a lot, but the process will likely take a while, and you won't get the cash straight away. Now imagine selling shares in a popular public company. The shares are listed on a major stock exchange, and lots of people want to buy them, so you're likely to make a quick sale. That's because the shares have high liquidity. What does this mean? And how does it impact global markets?
This is Liquidity: Unpacked.
Liquidity refers to how easily an asset or security can be sold at its market value. When liquidity is high, the sale can be made quickly. When liquidity is low, cashing in can take much longer. The most liquid asset available is cash itself, because no conversion is needed. It's already in the form of legal tender and it's ready to spend. This includes cash in savings or checking accounts.
In markets, high liquidity means there is both high demand and high supply of a particular asset, facilitating a quick sale. Some common examples of liquid assets include: stocks listed on major exchanges, like the New York Stock Exchange; U.S. Government bonds; exchange traded products like futures.
For traders, high liquidity means individual and institutional traders can buy and sell the assets they want when they want. This also makes it easier to hedge, which is when traders take a position in the opposite direction to reduce their risk.
In a low liquidity market, it's harder to hedge due to less market volume or number of assets, and less depth, or the distribution of prices. When volume and depth are high, the market is more liquid.
Liquidity is often linked to what's going on in the world. During times of market instability when prices fluctuate rapidly and unpredictably, sellers may look to sell quickly to minimize losses, which can drive prices down. Equally, other sellers may hold assets to ride out the volatility, which can reduce market depth.
The 2008 global financial crisis is one example of a liquidity shock. Banks found it harder to borrow and lend over fears of exposure to the collapsed mortgage market, and many supposedly liquid assets became unmarketable. Without liquid assets at their disposal, some financial institutions faced insolvency, so governments and regulatory bodies had to step in. The process of rebuilding market confidence took years. Since the crisis, increased regulatory oversight has offered some protection from liquidity shocks, but it's not foolproof. Major events like the COVID-19 pandemic can shake markets up, reducing liquidity and making it harder for economies to function.
Many building blocks are needed to establish a healthy market, but good liquidity remains one of the most fundamental.
Despite its high value, selling a house will likely take longer than selling shares in a popular public company. Much of this comes down to liquidity. Why are some assets more liquid than others? What happens when there’s a liquidity shock? And what’s the most liquid asset in the world? Discover why liquidity matters in global markets and in our everyday lives.
The material contained herein is intended as a general market and/or economic commentary and is not intended to constitute financial or investment advice. Any views or opinions expressed herein are solely those of the speakers and do not reflect the views of and opinions of JPMorgan Chase. This information in no way constitutes JPMorgan Chase research and should not be treated as such. Further, the views expressed herein may differ from that contained in JPMorgan Chase research reports. The information herein has been obtained from sources deemed to be reliable, but JPMorgan Chase makes no representation or warranty as to its accuracy or completeness.