| One of the important functions of the stock market is to ensure that investors are able to carry on transactions rapidly, efficiently and stably while keeping the cost as low as possible. In other words, the stock market must provide sufficient liquidity for the investors. When the stock market operates normally, the liquidity indeed is the deciding factor of the cost and risk of transactions. It will be considered as the most important factor when investors make investment decisions and evaluate assets. Under abnormal circumstances, the collapse of stock market is always directly related to serious insufficient liquidity. If liquidity disappears completely from market, the whole stock market will be damaged seriously. Therefore it is the basis on which the stock market being exists and keeps going normally.In the classical capital market theory, the evaluation of assets is supposed to be unrelated to liquidity, while in practice the investors in stock market are always concerned with the illiquidity cost of their portfolio and all kinds of factors during the course of price discovery. The liquidity is not only the result of investors'transactions, but also have a great impact on the price setting and the pattern of price movement in the stock market. It reflects many attributes of the whole process of stock trading while all factors in stock trading make an impact on market liquidity. Different from the previous studies on the roles of the liquidity, which only stress the market microstructure this paper focuses on market microstructure, investor behaviors, financial policies and their interactions by analyzing a whole transaction process.The paper first analyzes the connotation of market liquidity, with transaction cost, transaction volume and the waiting time being its main factors. The three factors compose attributes of liquidity------ tightness, depth, resiliency and immediacy. According to the four attributes, the paper induces, classifies and compares the liquidity measures and models used in the analysis of liquidity nowadays. It compares their strongpoint, shortcomings and why they are applicable, and figures out how to choose liquidity measures to analyze problems.Transforming the orders from a large number of investors to reasonable equilibrium price is the core function of market microstructure. Scientific and orderly microstructure will improve market liquidity. The paper describes Chinese stock market microstructure in a whole. Considering the characteristics of pure order trading mechanism, it analyzes the decision making process and price discovery procedure, and summaries the mechanism through which market microstructure affects market liquidity. It investigates how the trading mechanism, order types, information exposures, price control, and the other trading rules affect market liquidity respectively.The risk investment decisions and reciprocity among them are start-point that contributes to all stock market microstructure characteristics. The classical economics theory which stipulates rational investor as a condition could not explain behaviors of traders properly. This paper sums up the researches on behavior finance about investor's behavior and indicates the mechanism which investors affect market liquidity. On the basis of this, the behaviors of informed traders and noise traders and their liquidity value are investigated. The structure of market participants falls into three categories: informed traders vs. noise traders, limit-order provider vs. market-order provider, individual investors vs. institutional investors, each of them all having close relations with market liquidity.As the emerging stock market developed from transition economic stage, Chinese stock market liquidity has been evidently influenced by macroeconomic policies and measures made by supervising authority. This paper divides financial policies that affect stock market into sequent financial policies and scattering financial policies and analyzes the mechanism that makes an impact on liquidity. It also studies empirically the effects of macroeconomic variables, important financial policies and adjustment of ownership structure on market liquidity which reveals that liquidity of Chinese stock market has obvious effects of policy. Employing the transaction data from Shanghai Stock Exchange and Shenzhen Stock Exchange, the paper studies empirically the change of liquidity of Chinese stock market from the beginning, and compares the level of liquidity, transformation trend and stabilization of the two exchanges. According to the fluctuating orderliness, the period from 1991 to 2007 could be divided into five stages. The paper compares breadth wise the liquidity characteristics of each stage and concludes the transforming peculiarity of Chinese stock market liquidity. Finally, on the basis of colligating the former analysis results, the paper suggests improving liquidity by enhancing the construction of the system and leading market participants to develop healthily.
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