Newer capital markets are less volatile because they are less liquid. True or False?

Question

Newer capital markets are less volatile because they are less liquid.  True or False?

BlackTom AI · Accepted Answer

The question asks whether newer capital markets are less volatile because they are less liquid. 
Option 1: True. This claim is not accurate. In practice, lower liquidity tends to amplify price moves and increase volatility, not reduce it, especially in times of stress, because fewer participants and tighter bid-ask spreads can cause larger price jumps. 
Option 2: False. The statement as written makes a causal claim that weaker liquidity reduces volatility, which contradicts typical market dynamics where illiquidity often magnifies volatility. Higher liquidity generally dampens short-term price swings by providing more counterparties and tighter spreads, whereas reduced liquidity can lead to greater volatility as trades have a bigger impact on prices. 
Framing this differently, liquidity and volatility are related but inversely correlated in many scenarios: more liquid markets usually exhibit lower short-term volatility due to smoother price discovery, while less liquid markets can experience outsized moves for relatively small trades. Thus, the assertion that newer markets are less volatile due to being less liquid misstates the relationship between liquidity and volatility. 
To summarize the common-sense relationship: if liquidity improves, volatility tends to decrease; if liquidity deteriorates, volatility tends to increase. Therefore, the statement in option 1 is misleading, and option 2 correctly identifies the flaw in that reasoning.

BUSFIN 4236 SP2025 (5326) Capital Markets - FINAL EXAM- Requires Respondus LockDown Browser

Newer capital markets are less volatile because they are less liquid. True or False?

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