The Impact of Stock Market Illiquidity on Real UK GDP Growth

Chris Florakis, Gianluigi Giorgioni (), Alexandros Kostakis and Costas Milas
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Chris Florakis: University of Liverpool, UK

Working Paper series from Rimini Centre for Economic Analysis

Abstract: We empirically test the hypothesis that stock market illiquidity affects real UK GDP growth using data over the period 1989q1-2012q2. We conduct our empirical exercise within a standard linear model as well as a non-linear model, which allows for regime switching behavior in terms of a liquid versus an illiquid regime and over the phases of the business cycle. Our findings strongly support a statistically significant negative impact of stock market illiquidity over and above the usual macroeconomic controls on UK GDP growth; the impact becomes stronger during periods of highly illiquid market conditions and weak economic growth. Our out-of-sample forecasting analysis provides evidence in favor of a regime-switching model of illiquid versus liquid market conditions in predicting UK growth better than any other model; further, this very model is the only one to outperform the GDP growth forecasts published in the Bank of England’s Inflation Report.

Keywords: stock market illiquidity; divisia money; GDP growth; non-linear model (search for similar items in EconPapers)
JEL-codes: C32 C51 C52 G12 (search for similar items in EconPapers)
Date: 2012-11
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