Liquidity in second tier equity markets: evidence from London's Alternative Investment Market (AIM)

This paper studies liquidity provision in the Alternative Investment Market (AIM) of the London Stock Exchange. Our analysis shows that it is possible to generate sufficient liquidity in a small company market. Indeed, a small group of AIM stocks are found to trade frequently, exposing the investor to minimal execution risk. At the same time, we find that the majority of AIM stocks trade infrequently, with trades often clustered around a few days. We find the latter group to be further characterised by higher price volatility and wider spreads, indicating that for the majority of AIM stocks, immediacy risk is an issue of concern. When studying AIM stocks that were transferred from the Rule 4.2. market, we report a significant increase in trading activity, but surprisingly little change in liquidity as measured by either price volatility or trading costs. Finally, we develop a statistical model to identify the main determinants of liquidity. We find that a higher market capitalisation and a higher free float both contribute to a larger number of trades, lower trade concentration, lower price volatility and lower effective spreads. There also seems to be a technology effect, in that technology firms are more actively traded and enjoy lower trading costs, in the form of lower average effective spreads. At the same time, our empirical evidence seems to indicate that there is no "average" AIM stock, and that liquidity is therefore difficult to predict.