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TL;DR

The ability to buy or sell an asset quickly without significant price impact. Measured by bid-ask spread, depth, and resilience (how fast the book recovers after a large trade).

By Valenke Exam Prep Team·Last updated 2026-06-03

Liquidity

The ability to buy or sell an asset quickly without significant price impact. Measured by bid-ask spread, depth, and resilience (how fast the book recovers after a large trade).

Why it matters for interviews

Liquidity risk is distinct from market risk and is often underestimated. Strategies that work in liquid markets can fail in illiquid ones. Understanding liquidity metrics and their dynamics is crucial for execution and risk management.

Definition and Mathematical Foundation

The ability to buy or sell an asset quickly without significant price impact. Measured by bid-ask spread, depth, and resilience (how fast the book recovers after a large trade).

Application in Quantitative Finance

Liquidity risk is distinct from market risk and is often underestimated. Strategies that work in liquid markets can fail in illiquid ones. Understanding liquidity metrics and their dynamics is crucial for execution and risk management.

Related Terms

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Frequently Asked Questions

What is the Amihud illiquidity measure?▼
Daily absolute return divided by dollar volume: \( ILLIQ = |r|/V \). It measures price impact per unit of trading volume. Higher values indicate less liquid assets.
How does liquidity vary over time?▼
Liquidity follows intraday patterns (higher at open/close), deteriorates during market stress (liquidity spirals), and varies with market structure (maker-taker fees, tick size). Liquidity risk is often correlated with market risk.
What is a liquidity premium?▼
The extra return investors demand for holding illiquid assets. Empirically, less liquid stocks earn higher average returns, compensating for the difficulty and cost of trading them.