Product Market Power and Stock Market Liquidity
Jayant R. Kale
Yee Cheng Loon
Securities and Exchange Commission (SEC)
August 27, 2010
Journal of Financial Markets, Forthcoming
Theory predicts that since a firm with market power has more stable cash flows because of its ability to set prices in the product market, its stock price is less sensitive to order flow (Peress, 2010), which results in greater stock liquidity. We test this prediction on a large sample of firms and find that stock liquidity increases with market power because market power reduces return volatility. Further, consistent with theoretical predictions, the impact of market power on liquidity is more pronounced when information asymmetry is more severe, that is, for smaller firms and for firms with less analyst coverage. Our findings are robust to different measures of liquidity, market power, volatility, and alternative econometric model specifications.
Number of Pages in PDF File: 55
Keywords: Product market, Market power, Liquidity, Asymmetric information
JEL Classification: D4, D8, G1, L1
Date posted: March 18, 2009 ; Last revised: December 29, 2010
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