Liquidity Shocks and Stock Market Reactions

108 Pages Posted: 10 May 2012 Last revised: 26 Aug 2013

See all articles by Turan G. Bali

Turan G. Bali

Georgetown University - McDonough School of Business

Lin Peng

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance

Yannan Shen

CUNY Baruch College; Bentley University

Yi Tang

Fordham University - Gabelli School of Business

Multiple version iconThere are 3 versions of this paper

Date Written: August 23, 2013

Abstract

We find that the stock market underreacts to stock level liquidity shocks: liquidity shocks are not only positively associated with contemporaneous returns, but they also predict future return continuations for up to six months. Long-short portfolios sorted on liquidity shocks generate significant returns of 0.70% to 1.20% per month that are robust across alternative shock measures and after controlling for risk factors and stock characteristics. Furthermore, we show that investor inattention and illiquidity contribute to the underreaction: while both are significant in explaining short-term return predictability of liquidity shocks, the inattention-based mechanism is more powerful for the longer-term return predictability.

Keywords: Stock returns, liquidity shocks, stock market reactions, underreaction, investor attention

JEL Classification: G02, G10, G11, G12, G14, C13

Suggested Citation

Bali, Turan G. and Peng, Lin and Shen, Yannan and Shen, Yannan and Tang, Yi, Liquidity Shocks and Stock Market Reactions (August 23, 2013). Georgetown McDonough School of Business Research Paper No. 2012-02, Available at SSRN: https://ssrn.com/abstract=2055472 or http://dx.doi.org/10.2139/ssrn.2055472

Turan G. Bali (Contact Author)

Georgetown University - McDonough School of Business ( email )

3700 O Street, NW
Washington, DC 20057
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(202) 687-5388 (Phone)
(202) 687-4031 (Fax)

HOME PAGE: https://sites.google.com/a/georgetown.edu/turan-bali

Lin Peng

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance ( email )

17 Lexington Avenue
New York, NY 10010
United States

Yannan Shen

CUNY Baruch College ( email )

55 Lexington Ave 12-291
New York, NY 10010
United States
646-312-3242 (Phone)
646-312-3161 (Fax)

Bentley University ( email )

175 Forest Street
Waltham, MA 02145
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781-891-2652 (Phone)

HOME PAGE: http://https://faculty.bentley.edu/details.asp?uname=yshen1

Yi Tang

Fordham University - Gabelli School of Business ( email )

113 West 60th Street
New York, NY 10023
United States

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