Stock Liquidity and the Earnings-Return Asymmetry for Negative versus Positive Returns

53 Pages Posted: 2 Dec 2018

See all articles by June Cheng

June Cheng

Hong Kong Polytechnic University - Faculty of Business

Jing Fang

Hong Kong Polytechnic University

Linda A. Myers

University of Tennessee, Haslam College of Business, Accounting and Information Management

Date Written: October 1, 2018

Abstract

Prior research finds that the association between earnings and contemporaneous returns is larger for negative returns than for positive returns. This earnings-return asymmetry is often attributed to conditional conservatism (i.e., accounting rules adopt a higher accounting verification threshold for recognizing good news as gains than for recognizing bad news as losses). We argue that this asymmetry may also be driven by the lack of timeliness with which stock prices incorporate bad news. If this is the case, the earnings-return asymmetry will be weaker for firms with more liquid stocks because their stock prices reflect bad news more timely. In support of our argument, we find that the asymmetry becomes weaker (and even disappears) as stock liquidity increases. This suggests that for firms with illiquid stocks, the earnings-return asymmetry can exist without conditional conservatism. Using reductions in the minimum tick size as plausibly exogenous shocks to stock liquidity, we show that the effect of stock liquidity on the asymmetry is likely causal. Our findings support the conjecture in Dechow, Ge, and Schrand (2010) that variation in the earnings-return asymmetry may also reflect variation in the quality of the return generation process rather than conditional conservatism.

Keywords: Conditional conservatism, Stock liquidity, Earnings-return asymmetry, Asymmetric timeliness

JEL Classification: G14, G40, M40, M41

Suggested Citation

Cheng, June and Fang, Jing and Myers, Linda A., Stock Liquidity and the Earnings-Return Asymmetry for Negative versus Positive Returns (October 1, 2018). Available at SSRN: https://ssrn.com/abstract=3275226 or http://dx.doi.org/10.2139/ssrn.3275226

June Cheng

Hong Kong Polytechnic University - Faculty of Business ( email )

Hung Hom, Kowloon
Hong Kong

Jing Fang

Hong Kong Polytechnic University ( email )

11 Yuk Choi Rd
Hung Hom
Hong Kong

Linda A. Myers (Contact Author)

University of Tennessee, Haslam College of Business, Accounting and Information Management ( email )

Knoxville, TN
United States

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