Stock Market Declines and Liquidity

49 Pages Posted: 9 Mar 2006 Last revised: 13 Nov 2008

Wenjin Kang

Renmin University of China - Hanqing Institute

Allaudeen Hameed

National University of Singapore (NUS) - Department of Finance

S. Viswanathan

Duke University - Fuqua School of Business; Duke University - Department of Economics

Abstract

Consistent with recent theoretical models where binding capital constraints lead to sudden liquidity dry-ups, we find that negative market returns decrease stock liquidity, especially for high volatility stocks and during times of tightness in the funding market. The asymmetric effect of changes in aggregate asset values on liquidity and commonality in liquidity cannot be fully explained by changes in demand for liquidity or volatility effects. We document inter-industry spill-over effects in liquidity, which are likely to arise from capital constraints in the market making sector. We also find economically significant returns to supplying liquidity following periods of large drop in market valuations.

Keywords: Liquidity, Market decline, Liquidity commonality, Price reversal

JEL Classification: G19

Suggested Citation

Kang, Wenjin and Hameed, Allaudeen and Viswanathan, S., Stock Market Declines and Liquidity. Journal of Finance, Forthcoming; AFA 2007 Chicago Meetings Paper; EFA 2007 Ljubljana Meetings Paper. Available at SSRN: https://ssrn.com/abstract=889241 or http://dx.doi.org/10.2139/ssrn.889241

Wenjin Kang (Contact Author)

Renmin University of China - Hanqing Institute ( email )

59 Zhongguancun Street
Beijing, 100872
China

Allaudeen Hameed

National University of Singapore (NUS) - Department of Finance ( email )

Mochtar Riady Building
15 Kent Ridge Drive
Singapore, 119245
Singapore

HOME PAGE: http://www.bschool.nus.edu.sg/staff_profile/cv.asp?ID=3

S. Viswanathan

Duke University - Fuqua School of Business ( email )

Durham, NC 27708-0120
United States
919-660-7784 (Phone)
919-684-2818 (Fax)

Duke University - Department of Economics

213 Social Sciences Building
Box 90097
Durham, NC 27708-0204
United States

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