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Illiquidity and Earnings Predictability

45 Pages Posted: 4 Mar 2011 Last revised: 18 Mar 2013

Jon N. Kerr

City University of New York (CUNY) - Stan Ross Department of Accountancy

Gil Sadka

University of Texas at Dallas

Ronnie Sadka

Boston College - Carroll School of Management

Date Written: February 28, 2013

Abstract

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.

Keywords: stock prices, aggregate earnings, illiquidity, expected returns, expected earnings

JEL Classification: E32, G12, G14, M41

Suggested Citation

Kerr, Jon N. and Sadka, Gil and Sadka, Ronnie, Illiquidity and Earnings Predictability (February 28, 2013). Columbia Business School Research Paper No. 11-1. Available at SSRN: https://ssrn.com/abstract=1776082 or http://dx.doi.org/10.2139/ssrn.1776082

Jon N. Kerr (Contact Author)

City University of New York (CUNY) - Stan Ross Department of Accountancy ( email )

One Bernard Baruch Way, Box B12-225
New York, NY 10010
United States
646-312-3164 (Phone)
646-312-3161 (Fax)

Gil Sadka

University of Texas at Dallas ( email )

2601 North Floyd Road
Richardson, TX 75083
United States

Ronnie Sadka

Boston College - Carroll School of Management ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States

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