Trends in the liquidity of Hungarian financial markets – What does the MNB’s new liquidity index show?

The Magyar Nemzeti Bank measures the trends in the liquidity of Hungarian financial markets by means of a liquidity index and a related set of liquidity sub-indices. These liquidity indices relate to the four most important domestic financial markets (the EUR/HUF spot foreign exchange market, the USD/HUF FX swap market, the secondary market of Hungarian government bonds and the interbank unsecured money market), and are based on indicators that quantify the different dimensions of market liquidity (bid-ask spread, return-to-volume ratio, average size of transactions, number of transactions). The timeliness of this topic is supported by the fact that, in relation to the impact of the US sub-prime crisis, analysts and experts have started to focus their attention on the development of financial market liquidity again. Until mid-2006, the liquidity of Hungary’s domestic financial markets increased steadily, but in 2007 the trend-like growth in liquidity ceased. Looking at the last period of more than a half year, the liquidity of Hungarian financial markets fell suddenly several times during the turbulent periods. The magnitude of the decline was particularly considerable in the period of the government bond market liquidity problems in early March 2008. In these periods, the decline in liquidity was mainly attributable to a decline in market tightness, i.e. to an increase in the costs of trading, while market turnover usually did not decline significantly.