Market Liquidity

In business, economics or investment, market liquidity is an asset's ability to be sold without causing a significant movement in the price and with minimum loss of value. Money, or cash, is the most liquid asset, and can be used immediately to perform economic actions like buying, selling, or paying debt, meeting immediate wants and needs. However, currencies, even major currencies, can suffer loss of market liquidity in large liquidation events. For instance, scenarios considering a major dump of US dollar bonds by China or Saudi Arabia or Japan, each of which holds trillions in such bonds, would certainly affect the market liquidity of the US dollar and US dollar denominated assets. There is no asset whatsoever that can be sold with no effect on the market.

An act of exchange of a less liquid asset with a more liquid asset is called liquidation. Liquidity also refers both to a business's ability to meet its payment obligations, in terms of possessing sufficient liquid assets, and to such assets themselves.

Liquidity is defined formally in many accounting regimes and has in recent years been more strictly defined. For instance, the US Federal Reserve intends to apply quantitative liquidity requirements based on Basel III liquidity rules as of fiscal 2012. Bank directors will also be required to know of, and approve, major liquidity risks personally. Other rules require diversifying counterparty risk and portfolio stress testing against extreme scenarios, which tend to identify unusual market liquidity conditions and avoid investments that are particularly vulnerable to sudden liquidity shifts.