Financial Market Frictions and Learning from the Stock Price
53 Pages Posted: 13 Dec 2019
Date Written: November 12, 2019
Liquid stocks may attract short-term traders who could attenuate the informativeness of stock prices about long-run fundamentals. As a result, managers may be less (more) likely to rely on the market prices of more (less) liquid stocks when making real investment decisions. Supporting this conjecture, we show that real investment is more sensitive to market prices for less liquid stocks. Using decimalization as an exogenous shock to liquidity, we show that stocks that experienced the greatest increase in liquidity also experienced the greatest decrease in the investment-to-price sensitivity. Thus, we propose that, by discouraging short-termism, illiquidity can increase the efficacy of corporate resource allocation.
Keywords: financial market frictions, illiquidity, corporate investment, learning from the stock price, short-termism
JEL Classification: G14, G31
Suggested Citation: Suggested Citation