Liquidity and the business cycle

Randi Næs, Johannes Skjeltorp and Bernt Arne Ødegard ()
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Bernt Arne Ødegard: University of Stavanger, BI Norwegian School of Management and Norges Bank
Authors registered in the RePEc Author Service: Bernt Arne Ødegaard

No 2008/11, Working Paper from Norges Bank

Abstract: We show evidence of a contemporaneous relation between stock market liquidity and the business cycle. Stock market liquidity worsen when the economy is slowing down, and this effect is most pronounced for small firms. Using data for both the US and Norway, we find strong evidence that stock market liquidity predict the current and future state of the economy. We also show some evidence that can shed light on the link between stock markets and the real economy. Using stock ownership data from Norway, we find that the portfolio compositions of investors change with the business cycle, and that investor participation is correlated with market liquidity, especially for the smallest firms. This suggest a "flight to quality" during economic downturns where traders desire to move away from equity investments in general, and within their equity portfolios, move from smaller/less liquid stocks to large/liquid stocks. Our results suggest that an important explanation for the equity premium in general, and the equity size premium in particular, may be related to time variation in stock market liquidity at business cycle frequencies

Keywords: Market microstructure; Liquidity; Business cycles (search for similar items in EconPapers)
JEL-codes: G10 G20 (search for similar items in EconPapers)
Pages: 45 pages
Date: 2008-07-28
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Citations: View citations in EconPapers (2)

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https://www.norges-bank.no/en/news-events/news-pub ... pers/2008/WP-200811/

Related works:
Working Paper: Liquidity and the Business Cycle (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:bno:worpap:2008_11

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