Liquidity Shocks and Stock Market Reactions

Turan G. Bali (), Lin Peng (), Yannan Shen () and Yi Tang ()
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Turan G. Bali: McDonough School of Business, Georgetown University
Lin Peng: Zicklin School of Business, Baruch College
Yannan Shen: Zicklin School of Business, Baruch College
Yi Tang: Schools of Business, Fordham University

Koç University-TUSIAD Economic Research Forum Working Papers from Koc University-TUSIAD Economic Research Forum

Abstract: This paper investigates how the stock market reacts to firm level liquidity shocks. We find that negative and persistent liquidity shocks not only lead to lower contemporaneous returns, but also predict negative returns for up to six months in the future. Long-short portfolios sorted on past liquidity shocks generate a raw and risk-adjusted return of more than 1% per month. This economically and statistically significant relation is robust across alternative measures of liquidity shocks, different sample periods, and after controlling for various risk factors and firm characteristics. Furthermore, the documented effect is stronger for small stocks, stocks with low analyst coverage and institutional holdings, and for less liquid stocks. Our evidence suggests that the stock market underreacts to firm level liquidity shocks, and that this underreaction can be driven by investor inattention as well as illiquidity.

Keywords: Stock returns; liquidity shocks; stock market reactions; underreaction; investor attention. (search for similar items in EconPapers)
JEL-codes: C13 G02 G10 G11 G12 G14 (search for similar items in EconPapers)
Pages: 78 pages
Date: 2013-02
New Economics Papers: this item is included in nep-fmk and nep-mst
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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