Illiquidity Shocks and Asymmetric Stock Market Reactions Around the World: Is Underreaction or Illiquidity Spiral the Culprit?

76 Pages Posted: 20 Oct 2017 Last revised: 26 Oct 2018

See all articles by Te-Feng Chen

Te-Feng Chen

Hong Kong Polytechnic University

K.C. John Wei

Hong Kong Polytechnic University

Date Written: October 20, 2018

Abstract

Illiquidity shocks are negatively associated with future returns. There are two potential explanations: underreaction and illiquidity spiral. We find that negative illiquidity shocks generate upward price continuation, but positive illiquidity shocks lead to initial downward price continuation quickly followed by price reversal. Further analysis shows that the underreaction channel works well only in stocks with negative illiquidity shocks, whereas the illiquidity spiral channel is strongly supported in stocks with positive illiquidity shocks. Moreover, our results are not subsumed by the numerator component (i.e., volatility shocks) or denominator component (i.e., volatility shocks) of the illiquidity shocks.

Keywords: Illiquidity shocks; Underreaction; Illiquidity spiral; Capital constraints; Cross-section of stock returns

JEL Classification: G12, G15

Suggested Citation

Chen, Te-Feng and Wei, Kuo-Chiang (John), Illiquidity Shocks and Asymmetric Stock Market Reactions Around the World: Is Underreaction or Illiquidity Spiral the Culprit? (October 20, 2018). Asian Finance Association (AsianFA) 2018 Conference. Available at SSRN: https://ssrn.com/abstract=3056151 or http://dx.doi.org/10.2139/ssrn.3056151

Te-Feng Chen

Hong Kong Polytechnic University ( email )

Hung Hom, Kowloon
Hong Kong
+852 3400 3856 (Phone)

Kuo-Chiang (John) Wei (Contact Author)

Hong Kong Polytechnic University ( email )

11 Yuk Choi Rd
Hung Hom
Hong Kong

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