Market Microstructure and Liquidity Quiz

Market microstructure theory examines the impact of market structure and trading mechanisms on transaction costs and market quality, such as bid-ask spreads, price impact, and resilience. It affects liquidity and liquidity premia.

Liquidity refers to the ability to buy or sell a security quickly and with minimal or no price impact. It is difficult to define precisely because it has multiple facets and can be defined differently by different individuals. For example, some define liquidity as the ability to trade significant quantities of a security without affecting its price.

A market maker provides liquidity by taking the opposite position in a trade. When investors sell, the market maker buys, and vice versa. They facilitate trading by being willing to buy or sell securities at quoted prices.

<p>The law of one price states that securities with identical cash flows should have the same price. However, in markets with frictions, such as transaction costs and market imperfections, this law may not hold true. Frictions can lead to price disparities among securities with identical cash flows.</p> Signup and view all the answers

<p>Liquidity is not directly observable because it is a concept that encompasses various aspects. It is not easily quantifiable and can be subjective, making it challenging to precisely measure or define.</p> Signup and view all the answers