Stock Market Liquidity and Macro-Liquidity Shocks: Evidence from the 2007-2009 Financial Crisis

46 Pages Posted: 26 Sep 2011 Last revised: 28 May 2014

See all articles by Chris Florackis

Chris Florackis

University of Liverpool (UK)

Alexandros Kontonikas

University of Glasgow - Department of Economics

Alexandros Kostakis

University of Liverpool Management School; University of Manchester - Manchester Business School

Date Written: May 27, 2014

Abstract

We develop an empirical framework that links micro-liquidity, macro-liquidity and stock prices. We provide evidence of a strong link between macro-liquidity shocks and the returns of UK stock portfolios constructed on the basis of micro-liquidity measures between 1999-2012. Specifically, macro-liquidity shocks, which are extracted on the meeting days of the Bank of England Monetary Policy Committee (MPC) relative to market expectations embedded in 3-month LIBOR futures prices, are transmitted in a differential manner to the cross-section of liquidity-sorted portfolios, with liquid stocks playing the most active role. We also find that there is a significant increase in shares’ trading activity and a rather small increase in their trading cost on MPC meeting days. Finally, our results emphatically document that during the recent financial crisis the shocks-returns relationship has reversed its sign. Interest rate cuts during the crisis were perceived by market participants as a signal of deteriorating economic prospects and reinforced “flight to safety” trading.

Keywords: Liquidity Shocks, Monetary Policy, Market Micro-Structure, Stock Returns

JEL Classification: G12, E43, E44, E51, E52

Suggested Citation

Florackis, Chris and Kontonikas, Alexandros and Kostakis, Alexandros, Stock Market Liquidity and Macro-Liquidity Shocks: Evidence from the 2007-2009 Financial Crisis (May 27, 2014). Journal of International Money and Finance,Vo. 44, pp. 97–117. Available at SSRN: https://ssrn.com/abstract=1933846 or http://dx.doi.org/10.2139/ssrn.1933846

Chris Florackis

University of Liverpool (UK) ( email )

The Management School
University of Liverpool
Liverpool, L 697ZH
United Kingdom

Alexandros Kontonikas

University of Glasgow - Department of Economics ( email )

Adam Smith Building
Glasgow, Scotland G12 8RT
United Kingdom

Alexandros Kostakis (Contact Author)

University of Liverpool Management School ( email )

Chatham Building
Liverpool, L69 7ZH
United Kingdom

HOME PAGE: http://www.alexkostakis.com

University of Manchester - Manchester Business School ( email )

Booth Street West
Manchester, M15 6PB
United Kingdom

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