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Stock market liquidity and macro-liquidity shocks: Evidence from the 2007-2009 financial crisis

  • Chris Florackis
  • Alexandros Kontonikas
  • Alexandros Kostakis‌

We develop an empirical framework that links micro-liquidity, macro-liquidity and stock prices. We provide evidence of a strong link between macro-liquidity shocks and the returns of UK stock portfolios constructed on the basis of micro-liquidity measures between 1999- 2012. Specifically, macro-liquidity shocks, which are extracted on the meeting days of the Bank of England Monetary Policy Committee relative to market expectations embedded in 3- month LIBOR futures prices, are transmitted in a differential manner to the cross-section of liquidity-sorted portfolios, with liquid stocks playing the most active role. We also find that there is a significant increase in shares’ trading activity and a rather small increase in their trading cost on MPC meeting days. Finally, our results emphatically document that during the recent financial crisis the shocks-returns relationship has reversed its sign. Interest rate cuts during the crisis were perceived by market participants as a signal of deteriorating economic prospects and reinforced “flight to safety” trading.

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Paper provided by Business School - Economics, University of Glasgow in its series Working Papers with number 2013_13.

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Handle: RePEc:gla:glaewp:2013_13
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