45 Pages Posted: 4 Mar 2011 Last revised: 18 Mar 2013
Date Written: February 28, 2013
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: 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