Stock Liquidity Risk and the Cross-sectional Earnings-Returns Relationship

Zangina Isshaq, Robert Faff*

*Corresponding author for this work

Research output: Contribution to journalArticleResearchpeer-review

2 Citations (Scopus)

Abstract

We argue that a higher sensitivity to aggregate market-wide liquidity shocks (i.e., a higher liquidity risk) implies a tendency for a stock's price to converge to fundamentals. We test this intuition within the framework of the earnings-returns relationship. We find a positive liquidity risk effect on the relationship between return and expected change in earnings. This effect on the earnings-returns relationship is distinct from the negative effect observed for stock illiquidity level. Notably, the liquidity risk effect is evident (absent) during periods of neutral/low (high) aggregate market liquidity. We also show that the liquidity risk effect is dominant in firms that: (a) are of intermediate size; (b) are of intermediate book-to-market; and (c) are profit making.

Original languageEnglish
Pages (from-to)1121-1141
Number of pages21
JournalJournal of Business Finance and Accounting
Volume43
Issue number9-10
DOIs
Publication statusPublished - 1 Oct 2016
Externally publishedYes

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