Stock Liquidity Risk and the Cross-Sectional Earnings-Returns Relation

Forthcoming, Journal of Business Finance & Accounting, Volume 43, Issue 9-10.

34 Pages Posted: 12 Oct 2016

See all articles by Zangina Isshaq

Zangina Isshaq

University of Cape Coast

Robert W. Faff

University of Queensland

Date Written: October 11, 2016

Abstract

We argue that a higher sensitivity to aggregate market-wide liquidity shocks (i.e. a higher liquidity risk) implies a tendency for a stock’s price to converge to fundamentals. We test this intuition within the framework of the earnings-returns relation. We find a positive liquidity risk effect on the relation between return and expected change in earnings. This effect on the earnings-returns relation is distinct from the negative effect observed for stock illiquidity level. Notably, the liquidity risk effect is evident (absent) during periods of neutral/low (high) aggregate market liquidity. We also show that the liquidity risk effect is dominant in firms that: (a) are of intermediate size; (b) are of intermediate book-to-market; and (c) are profit making.

Keywords: Stock liquidity, Risk, Earnings-Returns relation

JEL Classification: G12

Suggested Citation

Isshaq, Zangina and Faff, Robert W., Stock Liquidity Risk and the Cross-Sectional Earnings-Returns Relation (October 11, 2016). Forthcoming, Journal of Business Finance & Accounting, Volume 43, Issue 9-10.. Available at SSRN: https://ssrn.com/abstract=2850889 or http://dx.doi.org/10.2139/ssrn.2850889

Zangina Isshaq

University of Cape Coast ( email )

PMB, UCC, GHANA
Department of English
Cape Coast, Central Region
Ghana

Robert W. Faff (Contact Author)

University of Queensland ( email )

St Lucia
Brisbane, Queensland 4072
Australia

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