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The Impact of Stock Market Illiquidity on Real UK GDP Growth

Author

Listed:
  • Chris Florakis

    (University of Liverpool, UK)

  • Gianluigi Giorgioni

    (University of Liverpool, UK)

  • Alexandros Kostakis

    (University of Liverpool, UK)

  • Costas Milas

    (University of Liverpool, UK)

Abstract

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.

Suggested Citation

  • Chris Florakis & Gianluigi Giorgioni & Alexandros Kostakis & Costas Milas, 2012. "The Impact of Stock Market Illiquidity on Real UK GDP Growth," Working Paper series 65_12, Rimini Centre for Economic Analysis.
    • Handle: RePEc:rim:rimwps:65_12
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    More about this item

    Keywords

    stock market illiquidity; divisia money; GDP growth; non-linear model;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection

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