Liquidity Shocks and Stock Market Reactions

108 Pages Posted: 13 Mar 2012 Last revised: 22 Sep 2013

Turan G. Bali

Georgetown University - Robert Emmett McDonough School of Business

Lin Peng

Baruch College/CUNY - Zicklin School of Business

Yannan Shen

Bentley University; CUNY Baruch College

Yi Tang

Fordham University - Gabelli School of Business

Multiple version iconThere are 3 versions of this paper

Date Written: August 23, 2013

Abstract

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

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

Turan G. Bali

Georgetown University - Robert Emmett McDonough School of Business ( email )

3700 O Street, NW
Washington, DC 20057
United States
(202) 687-5388 (Phone)
(202) 687-4031 (Fax)

HOME PAGE: http://msbonline.georgetown.edu/faculty-research/msf-faculty/turan-bali

Lin Peng (Contact Author)

Baruch College/CUNY - Zicklin School of Business ( email )

17 Lexington Ave., Box B10-225
New York, NY 10010
United States
(646)312-3491 (Phone)
(646)312-3451 (Fax)

Yannan Shen

Bentley University ( email )

175 Forest Street
Waltham, MA 02145
United States
781-891-2652 (Phone)

HOME PAGE: http://https://faculty.bentley.edu/details.asp?uname=yshen1

CUNY Baruch College ( email )

55 Lexington Ave 12-291
New York, NY 10010
United States
646-312-3242 (Phone)
646-312-3161 (Fax)

Yi Tang

Fordham University - Gabelli School of Business ( email )

113 West 60th Street
New York, NY 10023
United States

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