ICYMI – Financial markets have become more susceptible to liquidity shortages (BIS report)

The Bank for International Settlements have published research showing fnancial markets have become more susceptible to liquidity shortages. Citing the rise of algorithmic trading and increased market fragmentation.

From the BIS report, in brief:

• average bid-ask spread has significantly declined across stock, foreign exchange and government bond markets over the past 25 years, indicating improved average liquidity, the higher moments of the distribution (skewness and kurtosis) have increased in equity and bond markets.
• This suggests more frequent episodes of substantial illiquidity, highlighting increased market fragility.
• In contrast, FX markets have reduced the spread without a corresponding increase in illiquidity episodes.

BIS go on:

• We identify structural breaks in the time series of spread distributions and associate them with macroeconomic shocks and changing market conditions.
• Additionally, we find algorithmic trading and market fragmentation tend to lower average spreads but increase skewness, particularly in equity markets, underscoring the dual impact of these factors on market liquidity and vulnerability.
• Lastly, our simulation exercise suggests that a higher skewness of the bid-ask spread can directly undermine trading profits.

The better performance of FX markets is said to be more resilience potentially due to measures taken to curb unwanted behavior from high-frequency traders.

Here is the full BIS report if you are interested.

• Through stormy seas: how fragile is liquidity across asset classes and time?

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Who is the BIS, you ask? The Bank for International Settlements (BIS) is often referred to as the “central bank for central banks.” Here’s a quick overview:

• Founded: 1930
• Headquarters: Basel, Switzerland
• Purpose: To promote global monetary and financial stability through cooperation among central banks and other financial institutions.
• Key Functions:
  • Acts as a forum for central banks to exchange information and collaborate on monetary policy.
  • Provides banking services to central banks, such as holding reserves and facilitating international financial transactions.
  • Conducts economic and monetary research, providing data and insights to guide global financial stability.
  • Oversees and supports the implementation of international financial regulations, such as Basel Accords (Basel I, II, III).
• Members: Comprised of 63 central banks, representing countries from around the world.
• Governance: Managed by a Board of Directors, including representatives from member central banks.

The BIS is central to shaping the rules and frameworks that underpin the global financial system. It operates independently and works to prevent financial crises while fostering economic stability.

BIS HQ, Basle, Switerland

This article was written by Eamonn Sheridan at www.forexlive.com.