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The Impact of Stock Market Illiquidity on Real UK GDP Growth

  • Chris Florakis

    (University of Liverpool, UK)

  • Gianluigi Giorgioni

    (University of Liverpool, UK)

  • Alexandros Kostakis

    (University of Liverpool, UK)

  • Costas Milas

    ()

    (University of Liverpool, UK)

We empirically test the hypothesis that stock market illiquidity affects real UK GDP growth using data over the period 1989q1-2012q2. We conduct our empirical exercise within a standard linear model as well as a non-linear model, which allows for regime switching behavior in terms of a liquid versus an illiquid regime and over the phases of the business cycle. Our findings strongly support a statistically significant negative impact of stock market illiquidity over and above the usual macroeconomic controls on UK GDP growth; the impact becomes stronger during periods of highly illiquid market conditions and weak economic growth. Our out-of-sample forecasting analysis provides evidence in favor of a regime-switching model of illiquid versus liquid market conditions in predicting UK growth better than any other model; further, this very model is the only one to outperform the GDP growth forecasts published in the Bank of England’s Inflation Report.

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Paper provided by The Rimini Centre for Economic Analysis in its series Working Paper Series with number 65_12.

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Date of creation: Nov 2012
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Handle: RePEc:rim:rimwps:65_12
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