Illiquidity shocks and the comovement between stocks: New evidence using smooth transition

Patricia Chelley-Steeley, Neophytos Lambertides and Christos Savva ()

Journal of Empirical Finance, 2013, vol. 23, issue C, 1-15

Abstract: This paper extends the smooth transition conditional correlation model by studying for the first time the impact that illiquidity shocks have on stock market return comovement. We show that firms that experience shocks that increase illiquidity are less liquid than firms that experience shocks that decrease illiquidity. Shocks that increase illiquidity have no statistical impact on comovement. However, shocks that reduce illiquidity lead to a fall in comovement, a pattern that becomes stronger as the illiquidity of the firm increases. This discovery is consistent with increased transparency and an improvement in price efficiency. We find that a small number of firms experience a double illiquidity shock. For these firms, at the first shock, a rise in illiquidity reduces comovement while a fall in illiquidity raises comovement. The second shock partly reverses these changes as a rise in illiquidity is associated with a rise in comovement and a fall in illiquidity is associated with a fall in comovement. These results have important implications for portfolio construction and also for the measurement and evolution of market beta and the cost of capital as it suggests that investors can achieve higher returns for the same amount of market risk because of the greater diversification benefits that exist. We also find that illiquidity, friction, firm size and the pre-shock correlation are all associated with the magnitude of the correlation change.

Keywords: Stock liquidity; Comovements; Smooth transition model (search for similar items in EconPapers)
JEL-codes: G12 G14 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0927539813000248
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:23:y:2013:i:c:p:1-15

DOI: 10.1016/j.jempfin.2013.04.001

Access Statistics for this article

Journal of Empirical Finance is currently edited by R. T. Baillie, F. C. Palm, Th. J. Vermaelen and C. C. P. Wolff

More articles in Journal of Empirical Finance from Elsevier
Bibliographic data for series maintained by Catherine Liu ().