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Stock Market Liquidity and Country Fundamentals

Stock Market Liquidity and Country Fundamentals. Ser-Huang Poon Michael Rockinger Konstantinos Stathopoulos. Risk Management Consideration. Amihud (2002) Illiquid if price impact is high:. What drives liquidity (in different countries)?. Country fundamentals

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Stock Market Liquidity and Country Fundamentals

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  1. Stock Market Liquidity and Country Fundamentals Ser-Huang Poon Michael Rockinger Konstantinos Stathopoulos

  2. Risk Management Consideration

  3. Amihud (2002) Illiquid if price impact is high:

  4. What drives liquidity (in different countries)? • Country fundamentals • Computer technology, automated trading • Liquidity funding management and territory of operation • Risk regulations and territorial divide

  5. Liquidity Black Hole • Liquidity dries up during sell-off and asset can be sold only at a fire-sale price (price decline scenario). • Computer models used by different traders are similar. • Financial institutions are regulated in the same way and respond the same way to changes in volatility and correlation. • Herding • Liquidity funding management

  6. “Amihud’s email” • Volatility of economic variables • Legal variables • Country economic variables

  7. Legal Variables • Legal origin • Financial regulation • Insider trading and other laws • Enforcement variables

  8. Volatility of Economic Variables • Volatility of industrial production or other index of economic activity • Volatility of monetary variables • Various definition of money • Interest rate

  9. Country Economic Variables • Per capita income, growth, new investment, new firms • Investment by individuals (India, China) • Institution’s activity (% managed by funds) • Market cap compared to economy • Measure of float(???), in some countries, the market float is large but the float is small.

  10. Capital Market Governance Daouk, Lee and Ng (2006, JCF) • CMG index • Earnings opacity • Enforcement of insider laws, • Removal of short selling restrictions • Performance • Low cost of equity • High liquidity • Efficient pricing

  11. Capital Market Governance Daouk, Lee and Ng (2006, JCF) • 32 countries; Not focus on “crisis” • Good governance • => good performance • => liquidity • Not focus on “crisis”

  12. Sample: 37 Stock Markets 1996-2007

  13. Illiquidity Measure 1

  14. Illiquidity Measure 2

  15. Illiquidity Measure 3

  16. Regional Illiquidity Measures (Mean)

  17. Illiquidity Measures (Mean) by Legal Origin

  18. Rank correlation Volatility of economic variables

  19. Rank correlation Market Characteristics & Economic variables

  20. Rank correlation Legal variables

  21. Rank correlation Deouk et. al. variables for capital market governance

  22. Regional Illiquidity Measures

  23. Liquidity & the 1987 Crash Amihud (1990, JPM) • Period I: Oct5-Oct9, • Period II: Oct19, • Period III: Oct30 • Period II (t) vs. Period I (t-1) • Period III (t) vs. Period II (t-1)

  24. Liquidity & the 1987 Crash Amihud (1990, JPM) • Stocks that experienced a greater increase in bid-ask spread suffer a greater price decline during the crash => liquidity is a price factor • Alpha2 is insignificant during the crash (II vs. I) but significantly negative afterwards (III vs. II) => flight to quality • By the end of 1987, spread had narrowed but remained higher than before Oct => persistence

  25. To Do List: • Compare CRSP-NYSE vs. NASDAC • Study spread on e.g. Korea, Malaysia vs. US • Riskmetrics’s individual company governance scores • More robust econometrics • Managing liquidity-VaR

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