Illiquidity and Earnings Predictability
Jon N. Kerr
Columbia University - Columbia Business School
Columbia Business School - Accounting, Business Law & Taxation
Boston College - Carroll School of Management
February 28, 2013
Columbia Business School Research Paper No. 11-1
This paper studies whether illiquidity affects the predictability of fundamental valuation variables. Firm-level, cross-sectional analyses show that returns of illiquid stocks contain less information about their firm's future earnings growth compared to those of more liquid stocks. A natural experiment utilizing an exogenous variation in liquidity amid the reduction of tick size on the NYSE indicates that an improvement in liquidity causes an increase in earnings predictability. At the aggregate level, stock returns contain less information about future growth in aggregate earnings, GNP, and industrial production during illiquid periods. The results highlight the importance of liquidity for forecasting fundamentals and stock-price efficiency.
Number of Pages in PDF File: 45
Keywords: stock prices, aggregate earnings, illiquidity, expected returns, expected earnings
JEL Classification: E32, G12, G14, M41working papers series
Date posted: March 4, 2011 ; Last revised: March 18, 2013
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