108 Pages Posted: 13 Mar 2012 Last revised: 22 Sep 2013
Date Written: August 23, 2013
We find that the stock market underreacts to stock level liquidity shocks: liquidity shocks are not only positively associated with contemporaneous returns, but they also predict future return continuations for up to six months. Long-short portfolios sorted on liquidity shocks generate significant returns of 0.70% to 1.20% per month that are robust across alternative shock measures and after controlling for risk factors and stock characteristics. Furthermore, we show that investor inattention and illiquidity contribute to the underreaction: while both are significant in explaining short-term return predictability of liquidity shocks, the inattention-based mechanism is more powerful for the longer-term return predictability.
Keywords: Expected stock returns, liquidity, stock market reactions, underreaction, investor attention
JEL Classification: G02, G10, G11, G12, G14, C13
Suggested Citation: Suggested Citation
Bali, Turan G. and Peng, Lin and Shen, Yannan and Tang, Yi, Liquidity Shocks and Stock Market Reactions (August 23, 2013). Fordham University Schools of Business Research Paper No. 2020476. Available at SSRN: https://ssrn.com/abstract=2020476 or http://dx.doi.org/10.2139/ssrn.2020476
By Andrew Ang