The role of liquidity risk in shaping the dynamics of the Maltese equity market

Abstract

Liquidity is a fundamental feature of shaping equity dynamics, investor participation and trading activity (Amihud, 2002; Chordia et al., 2005). Liquidity risk arises when securities cannot easily be traded, which is a recurring issue in small and less active markets (Lesmond et al., 1999; Bekaert et al., 2005). The rationale of this study was to examine the relationship between liquidity risk and selected market variables in the Maltese equity market, specifically volume traded, value traded, bid-ask spreads, stock price and days of stale pricing. A mixed-methods approach was employed using both quantitative and qualitative analysis through secondary data and semi-structured interviews with industry professionals. The empirical findings revealed that liquidity risk is the most strongly associated with trading activity (volume traded and value traded). Moreover, the interviewees further highlighted that structural constraints such as limited free float and the absence of a market maker discourage active trading. The study concludes that liquidity risk poses a persistent challenge to the Maltese equity market, constraining both investor flexibility and issuers’ cost of capital. Based on these findings, the research recommends that policymakers and regulators consider measures to enhance liquidity, including the introduction of market makers, tax incentives for both retail and institutional participants and potential reforms to the free float requirements. Further research is encouraged to compare Malta’s findings with other small developed and emerging markets, to identify transferable policy lessons.