Stock Market Liquidity and Macro-Liquidity Shocks: Evidence from the 2007-2009 Financial Crisis

Chris Florackis, Alexandros Kontonikas () and Alexandros Kostakis

No 2013-58, SIRE Discussion Papers from Scottish Institute for Research in Economics (SIRE)

Abstract: We develop an empirical framework that links micro-liquidity, macro-liquidity and stock prices. We provide evidence of a strong link between macro-liquidity shocks and the returns of UK stock portfolios constructed on the basis of micro-liquidity measures between 1999-2012. Specifically, macro-liquidity shocks, which are extracted on the meeting days of the Bank of England Monetary Policy Committee relative to market expectations embedded in 3-month LIBOR futures prices, are transmitted in a differential manner to the cross-section of liquidity-sorted portfolios, with liquid stocks playing the most active role. We also find that there is a significant increase in shares’ trading activity and a rather small increase in their trading cost on MPC meeting days. Finally, our results emphatically document that during the recent financial crisis the shocks-returns relationship has reversed its sign. Interest rate cuts during the crisis were perceived by market participants as a signal of deteriorating economic prospects and reinforced flight to safety trading.

Keywords: Liquidity Shocks; Monetary Policy; Market Micro-Structure; Stock Returns (search for similar items in EconPapers)
Date: 2013
New Economics Papers: this item is included in nep-mac and nep-mon
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Related works:
Journal Article: Stock market liquidity and macro-liquidity shocks: Evidence from the 2007–2009 financial crisis (2014)
Working Paper: Stock market liquidity and macro-liquidity shocks: Evidence from the 2007-2009 financial crisis
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Persistent link: https://EconPapers.repec.org/RePEc:edn:sirdps:485

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