Stock Market Returns and Liquidity: Dynamic Relationships and Causality
University of Maryland, Eastern Shore - School of Business and Technology; University of Maryland, College Park
November 17, 2012
Journal of Trading, 9(1), 34-40. January, 2014.
This study examines the impulse response functions and causality test of stock market returns and market-wide liquidity as measured by share turnover (the total number of shares traded over a period divided by the average number of shares outstanding for the period). The analyses of the monthly data spanning from 1926 to 2011 of the NYSE share volume turnover and returns on the NYSE stock portfolios show that the returns on the NYSE value-weighted stock portfolio are immediately negative in the first month following the NYSE share turnover shock; however, the returns become positive after five months following the shock. The returns on the NYSE largest stock portfolio are negative for the first five months following the share turnover shock. There is a significant jump in the NYSE share turnover in the first month following the shock of the returns on the NYSE value-weighted and equal-weighted portfolios; this finding is consistent with the overconfidence theory. The causality test results indicate that stock returns and liquidity Granger cause each other. The results of this study offer important information and implications for investment and risk management.
Number of Pages in PDF File: 11
Keywords: liquidity, liquidity shocks, share turnover, stock market returns
JEL Classification: G12, G14Accepted Paper Series
Date posted: November 18, 2012 ; Last revised: January 25, 2014
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