Recent Advances in the Relationship between Stock Liquidity and Informed Trading

This study examines the relationship between informed trading and stock liquidity in automated markets with high-frequency trading. Using a dataset of S&P 500 firms, we find that informed trading enhances liquidity in short timeframes (daily and weekly) by increasing trading volume and market depth. However, this effect diminishes over longer timeframes (monthly, quarterly, and yearly), indicating that the liquidity benefits of informed trading are transient. Additionally, our findings highlight the varying effectiveness of liquidity measures across different data frequencies. High-frequency measures (Spread and Effective Spread) capture short-term liquidity fluctuations more effectively, while low-frequency measures (e.g., Amihud’s illiquidity measure) provide better insights into long-term liquidity trends.