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Title: Illiquidity shocks and the comovement between stocks: New evidence using smooth transition
Authors: Chelley-Steeley, Patrìcia Lorraine 
Lambertides, Neophytos 
Savva, Christos S. 
Major Field of Science: Social Sciences
Field Category: Economics and Business
Keywords: Comovements;Smooth transition model;Stock liquidity
Issue Date: Sep-2013
Source: Journal of Empirical Finance, 2013, vol. 23, pp. 1-15
Volume: 23
Start page: 1
End page: 15
Journal: Journal of Empirical Finance 
Abstract: This paper extends the smooth transition conditional correlation model by studying for the first time the impact that illiquidity shocks have on stock market return comovement. We show that firms that experience shocks that increase illiquidity are less liquid than firms that experience shocks that decrease illiquidity. Shocks that increase illiquidity have no statistical impact on comovement. However, shocks that reduce illiquidity lead to a fall in comovement, a pattern that becomes stronger as the illiquidity of the firm increases. This discovery is consistent with increased transparency and an improvement in price efficiency. We find that a small number of firms experience a double illiquidity shock. For these firms, at the first shock, a rise in illiquidity reduces comovement while a fall in illiquidity raises comovement. The second shock partly reverses these changes as a rise in illiquidity is associated with a rise in comovement and a fall in illiquidity is associated with a fall in comovement. These results have important implications for portfolio construction and also for the measurement and evolution of market beta and the cost of capital as it suggests that investors can achieve higher returns for the same amount of market risk because of the greater diversification benefits that exist. We also find that illiquidity, friction, firm size and the pre-shock correlation are all associated with the magnitude of the correlation change.
ISSN: 0927-5398
DOI: 10.1016/j.jempfin.2013.04.001
Rights: © Elsevier
Type: Article
Affiliation : Aston University 
Cyprus University of Technology 
Appears in Collections:Άρθρα/Articles

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