Illiquidity Shocks: U.S. and International Evidence

Abstract

We examine the return impact of illiquidity shocks. Consistent with an illiquidity spiral, positive shocks are followed by persistent negative returns and increased illiquidity. The illiquidity spiral dissipates because of the illiquidity premium driven increase in expected returns. The positive illiquidity shock is followed by a negative cash flow component of returns that is initially larger (in absolute terms) than the positive discount rate component, which becomes larger in later periods consistent with the increase in expected returns. The impact of illiquidity shocks on returns in global and developed markets (excluding the US) is similar to that in the U.S.

Keywords: Illiquidity shocks; Continuation; Reversal; Market Crash

JEL Classification: G11; G12; G14; G15; G41