Study On Securities Pricing Based On Liquidity

Liquidity is the most important area of market microstructure researches. Because effective price finding has been related with high liquidity and has stronger information efficiency, the market structure providing high liquidity and enhancing effective price finding will be very important to capital markets. Based on market microstructure, the dissertation studies the liquidity and price formation of security markets.After analyzing conditional theories about market microstructure and liquidity, the dissertation extends the definition about liquidity, which is the probability of trading large volume securities under no price volatility. When an asset can interchange with cash, the asset has liquidity. So, liquidity is the capability that investors can rapidly trade large volume assets by rational prices according to market' demand and supply. The dissertation compares the liquidity measures and security trading mechanisms among countries. The order formations will affect the market liquidity. Because limit orders assume trading risk or adverse selection risk, the market makers who submit limit orders will obtain better trading prices than those who submit market orders. The difference between prices is the compensation for liquidity. If liquidity is not compensated, market makers will not provide market liquidity and the market will be halted. The dissertation studies the price formation in three basic trading mechanisms including market making market, continuous auction market and call auction market. We argue that both of the security demand functions and security price functions are linear in equilibrium. However, three trading mechanisms have large differences in liquidity providing. In continuous auction market, liquidity is provided by limit orders. When information given, the depth of limit order has direct proportion with market liquidity. If the bid-ask orders are imbalance, some orders will not be executed, or the trading will be halted. In call auction market, the price reflects the accumulation of market information, its efficiency is higher than in continuous auction market. When continuous auction market is failure, the call auction market can be still operated. In market making market, the liquidity is higher than in auction market, but while the market makers enhance the liquidity, they affect market efficiency.In multi-periods trading, market makers' return will rely on changes of security, volume of market makers and risk adverse coefficient. If market makers are risk neuter,the price changes from liquidity will disappear. While the market liquidity origins from the market makers' absorbing abnormal demands, the market makers are compensated by security trading. For investors, they can trade immediately by assuming costs or wait to next period to trade. When costs assumed by market makers goes to zero, the market marker number of involving competition will goes to infinity and the market will have infinite liquidity. In two-market trading, if ignoring trading costs, the two-market conjecture equilibrium will not exist unless the two markets have the same trader volume and variance. Even the two markets are the same trader volume and variance, the conjecture equilibrium will not stable but a knife-equilibrium. If traders adopt pure strategy, the knife-equilibrium will not exist. If traders adopt mix strategy, the equilibrium will possibly exist.The dissertation studies the issue that the expected security return has relation to expected illiquidity risk and expected market portfolio illiquidity risk. Liquidity is time-varying and persistent. Persistent liquidity implies that returns are predictable. High illiquidity today predicts highly expected illiquidity next period, implying a highly required return. The dissertation analyzes market microstructure of China security. Due to the only order forms in market, the execution risk of limit order is very strong. Because of the uniform price ticks, the bid-ask spread of low price securities is big and the trading costs are high. In our sec...