Liquidity

Liquidity refers to the ease with which an asset can be bought or sold in the market, or the ability of an entity to meet short‑term obligations without experiencing a significant loss of value. Broadly, liquidity can be considered in two senses: asset liquidity, the ease of converting an asset into cash, and funding liquidity, the ability to secure cash or funding to meet obligations as they come due.

Asset liquidity is typically higher for assets with active markets, deep order books, and transparent pricing, such as cash and government bonds, and lower for real estate or private equity. Market liquidity is often indicated by a narrow bid-ask spread, high trading volume, and deep market depth; in stressed conditions these measures can deteriorate rapidly, increasing price impact for trades.

Liquidity risk arises when an asset cannot be sold promptly or at a fair price, or when cash inflows are insufficient to meet obligations. Companies manage liquidity through cash reserves, credit lines, and projections; banks monitor liquidity ratios and conduct stress tests to ensure they can withstand funding stresses.

Policy and regulation also affect liquidity. Central banks may offer liquidity facilities during crises to stabilize markets, and regulatory frameworks such as liquidity coverage requirements aim to ensure financial institutions hold sufficient liquid assets. Liquidity is context-dependent: a market may be liquid under normal conditions but become illiquid during periods of stress.