Stock Price Synchronicity and Liquidity
39 Pages Posted: 13 Mar 2008 Last revised: 8 Feb 2009
Date Written: September 2008
In this paper, we conjecture that stock price synchronicity can affect the adverse information risk faced by market makers and therefore the liquidity of the stock. We provide empirical evidence that is consistent with our conjecture. We find that stocks which co-move more with the market index have higher liquidity, computed based on effective spread, price impact or Amihud illiquidity measures. The results are obtained after controlling for cross-sectional differences in firm size, price levels, total and idiosyncratic volatilities, and are robust to both S&P and non S&P index stocks. Besides market co-movement, industry wide component in returns also reduces the adverse selection risk and improves the liquidity. We also find results related to the indexing effect. Following the addition to the S&P 500, a firm that experiences an increase in co-movement with the market is more likely to be accompanied by an improvement in liquidity. We also provide evidence that the lower bid-ask spread of ETFs is due to their relatively large stock price synchronicity.
Keywords: Price Synchronicity, Liquidity
JEL Classification: G19
Suggested Citation: Suggested Citation