50 Pages Posted: 24 Sep 2007 Last revised: 18 Feb 2011
Date Written: January 27, 2010
This paper examines the mechanism by which the incorporation of information into prices leads to cross-autocorrelations in stock returns. We present a simple model where trading on private information occurs first in the large stocks and is transmitted to small stocks with a lag. Such trading impacts large stock liquidity, so that, in equilibrium, large stock illiquidity portends stronger cross-autocorrelations. Empirically, we find that the lead-lag relation between large and small stocks increases with lagged illiquidity indicators of large stocks. Further, order flows in large stocks significantly predict returns of small stocks when large stock spreads are high, at both the market and industry levels. In addition, the role of order flow and liquidity in predicting small stock returns is stronger prior to macro announcements (when information-based trading is more likely).
Keywords: lead-lag, returns, small stocks, large stocks, microstructure, information
JEL Classification: G10, G14
Suggested Citation: Suggested Citation
Chordia, Tarun and Sarkar, Asani and Subrahmanyam, Avanidhar, Liquidity Dynamics and Cross-Autocorrelations (January 27, 2010). FRB of New York Staff Report No. 303. Available at SSRN: https://ssrn.com/abstract=1016117 or http://dx.doi.org/10.2139/ssrn.1016117
By Andrew Ang