Liquidity shocks and the negative premium of liquidity volatility around the world

Frank Yulin Feng, Wenjin Kang and Huiping Zhang

Journal of International Money and Finance, 2023, vol. 139, issue C

Abstract: We find that liquidity volatility negatively affects stock returns across international markets. This association remains consistent across various liquidity metrics and cannot be attributed to the influence of idiosyncratic volatility. Further analysis shows that the omitted liquidity decrease variable is the key driver of the negative premium of liquidity volatility. Considering the asymmetrical impact of liquidity decrease and increase on future stock returns, stocks displaying high liquidity volatility tend to experience significant liquidity decreases, which lead to lower average returns. Once the liquidity decrease is integrated into the pricing model, the negative return premium of liquidity volatility dissipates. Subsequent analysis underscores that the effect of liquidity decrease on returns is more pronounced in markets and periods characterized by diminished efficiency and heightened arbitrage costs.

Keywords: Stock return; Liquidity volatility; Liquidity decrease; International equity market; Return predictability (search for similar items in EconPapers)
JEL-codes: F37 G12 G15 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:139:y:2023:i:c:s0261560623001675

DOI: 10.1016/j.jimonfin.2023.102966

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