Liquidity in The World Market

Understanding Liquidity in the Global Market

In the realm of the global economy, the stock market serves as a pivotal component, functioning as a key microstructural element that contributes to the liquidity of the financial sector. Over the past 13 years, the total market capitalization of the world stock market has more than doubled, witnessing a remarkable increase of approximately 133% since 2003 (Iskyan, 2016). This surge in popularity has led to a growing tendency among individuals to invest in the stock market. However, the journey towards this heightened interest has not been without its challenges, as the market is frequently subject to various shocks and volatility. Historically, stock market volatility has averaged around 20% annually and 5.8% monthly (Ibbotson, 2011). In such an unpredictable environment, investors often rely on stock market liquidity as a foundational aspect of their investment strategies, closely monitoring the performance of companies as this has significant implications for listed firms (Wuyts, 2017).

In the face of economic volatility, determining the precise value of a firm becomes increasingly challenging. Investors often find themselves perplexed, leading to investments in less-than-ideal securities. Consequently, economists and investors globally are striving to uncover methodologies that can elucidate the interplay between volatility, liquidity, and the valuation of firms. Under these circumstances, stock market liquidity has emerged as a critical focus for investors seeking to ascertain firm value. The liquidity of a stock plays a central role in its valuation, acting as the lifeblood of the security market from the perspectives of investors, traders, and other stakeholders (Ali, 2016). Generally, higher liquidity or returns correlate with greater investor interest in a particular stock.

Liquidity can be understood as the ease with which an asset can be converted into cash without a significant loss in value or incurring transaction costs (Dalgaard, 2009). In the context of the stock market, liquidity refers to the ability to trade shares at prices that closely reflect current market values, where "ease" encompasses both speed and price (European Systematic Risk Board [ESRB], 2016). It serves as a crucial indicator of stock market development, signifying how well the market facilitates capital allocation and enhances prospects for long-term economic growth (Khaliq, 2013).

Challenges of Stock Market Liquidity in Emerging Economies

While Bangladesh is classified as an emerging economy, its stock markets exhibit inefficiencies and instability when compared to developed nations. According to World Bank statistics (2017), the ratio of total value traded in the stock market to GDP for Bangladesh has fluctuated significantly: 1.86% in 2000, 0.17% in 2004, 3.02% in 2010, and 0.38% in 2014. This data highlights the erratic behavior of the market. Consequently, assessing the liquidity and value of listed firms in this turbulent environment presents significant challenges.

Research on the relationship between stock liquidity and firm value has yielded mixed results. Some studies indicate a positive relationship, while others show negative or insignificant correlations. For instance, Fang, Neo, and Tice (2009) found that increased liquidity decimalization positively impacts firm performance by providing more information to investors. Similarly, Sidhu (2016) identified a positive correlation between Amivest liquidity and Tobin’s Q. However, contrasting findings have emerged, with some studies suggesting that firm size, liquidity, and value are interrelated, as noted by Ban (1981) and Amihud and Mendelson (1986). This indicates that various factors, including liquidity, corporate profitability, social responsibility, company size, and corporate governance, play a role in overall market performance (Moeljadi, 2014; Jonathan, 2003).

Research Objectives

The primary objective of this study is to investigate the impact of stock market liquidity on firm value. To achieve this, the following specific objectives have been outlined:

• To determine the stock liquidity of selected companies.
• To examine the effect of stock liquidity on the value of firms, specifically banks and non-banking financial institutions (NBFIs).
• To provide a comparative analysis of banks and NBFIs in Bangladesh regarding the impact of liquidity on firm value.

Literature Review

Despite the existence of numerous studies examining stock market liquidity and its effects on firm value, many findings remain contentious. For instance, Fang et al. (2009) explored the causal relationship between stock market liquidity and firm performance, identifying that an increase in liquidity decimalization positively influences firm performance by enhancing investor information availability. Sidhu (2016) employed random effects panel regression to analyze Indian manufacturing firms, revealing a positive relationship between Amivest liquidity and Tobin’s Q. Similarly, Zhang et al. (2017) conducted a quasi-natural experiment in China, demonstrating a positive relationship between liquidity and firm value.

Furthermore, research conducted by Ali, Mahmud, and Lima (2016) in Iraq corroborated these findings, indicating that firms with liquid stocks exhibit better value as measured by Tobin's Q. Conversely, studies by Kausar, Nazir, and Butt (2014) found a negative relationship between capital structure and firm value, suggesting that different sectors may yield varying results.

In the context of Bangladesh, there is a noticeable gap in research specifically addressing the relationship between stock liquidity and firm value, particularly concerning banks and NBFIs. Therefore, this study aims to fill this gap by exploring the impact of liquidity on the value of financial institutions in Bangladesh.

Methodology

This study employs an explanatory research design, relying on secondary data for quantitative analysis. The primary focus is to assess stock market liquidity and its effect on firm value among banks and NBFIs in Bangladesh. The sample includes annual reports from 27 banks and 11 NBFIs listed on the Dhaka Stock Exchange (DSE) from 2007 to 2016, resulting in a balanced panel dataset.

Table 1: Sample Selection

The data for liquidity calculation will be derived from daily trading volumes and returns of selected firms, sourced from the DSE and AmiBroker. The study will analyze various control variables, including firm size, age, leverage, and asset growth, to understand their influence on liquidity and firm value.

In conclusion, understanding liquidity in the stock market is crucial for investors and firms alike. As markets evolve, especially in emerging economies like Bangladesh, further research is essential to unveil the complexities surrounding liquidity and its impact on firm value.

References

Ali, M. (2016). The impact of liquidity on firm value: Evidence from Iraq. Journal of Economic Studies.

Amihud, Y., & Mendelson, H. (1986). Asset pricing and the bid-ask spread. Journal of Financial Economics.

Fang, L., Neo, H., & Tice, S. (2009). The impact of liquidity on firm performance. Journal of Financial Markets.

Ibbotson, R. G. (2011). Stocks, bonds, bills, and inflation: 2011 yearbook. Morningstar.

Khaliq, A. (2013). Stock market liquidity and economic growth. International Journal of Economics and Finance.

Sidhu, J. (2016). Stock market liquidity and firm value: Evidence from India. International Journal of Finance & Banking Studies.

Wuyts, S. (2017). The role of liquidity in firm valuation. Journal of Financial Research.

World Bank. (2017). Bangladesh stock market statistics.

Zhang, Z., Huang, Q., & Chen, H. (2017). Stock liquidity and firm value: Evidence from China. Journal of Corporate Finance.