How Do Shocks Arise and Spread Across Stock Markets? A Microstructure Perspective

Abstract

We study intraday, market-wide shocks to stock prices, market liquidity, and trading activity on international stock markets and assess the relevance of recent theories on “liquidity dry-ups” in explaining how such shocks arise and spread across markets. Market-wide price shocks are prevalent and large, with rapid spillovers across markets. However, price shocks are predominantly driven by information; they do not revert and are often associated with macroeconomic news. Furthermore, liquidity shocks are typically isolated and transitory. We find little evidence that liquidity effects foment price shocks or non-fundamental contagion. Overall, market-wide liquidity dry-ups are of little concern to international investors.

Keywords: Equity markets, jumps, financial crises, contagion, liquidity, trading activity

JEL Classification: G12, G15