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 language | English |
---|---|
Pages (from-to) | 1121-1141 |
Number of pages | 21 |
Journal | Journal of Business Finance and Accounting |
Volume | 43 |
Issue number | 9-10 |
DOIs | |
Publication status | Published - 1 Oct 2016 |
Externally published | Yes |