Review of Financial Studies Vol. 27 No. 5 2014
Liquidity Shocks and Stock Market Reactions
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.
- Volume
- 27
- Issue
- 5
- Pages
- 1434-1485
- Sources
- bibtex:phds-export.bib