Scandinavian Working Papers in Economics
UiS Working Papers in Economics and Finance,
University of Stavanger
No 2009/1: Liquidity and the Business Cycle
Randi Naes, Johannes Skjeltorp and Bernt Arne Odegaard ()
Additional contact information
Randi Naes: Ministry of Industry
Johannes Skjeltorp: Norges Bank
Bernt Arne Odegaard: University of Stavanger, Postal: University of Stavanger, NO-4036 Stavanger, Norway
Abstract: We show evidence of a contemporaneous relation between stock market liquidity and the business cycle. Stock market liquidity worsen when the economy is slowing down, and vice versa. This effect is most pronounced for small firms. Using data for both the US and Norway, we find strong evidence that stock market liquidity predict the current and future state of the economy. We also show some evidence that can shed light on the link between stock markets and the real economy. Using stock ownership data from Norway, we find that the portfolio compositions of investors change with the business cycle. Our results suggests a flight to quality during economic downturns where equity traders move from smaller/less liquid stocks to large/liquid stocks. Our results suggest that an important explanation for the equity premium in general, and the equity size premium in particular, may be related to time variation in stock market liquidity at business cycle frequencies.
Keywords: Market Microstructure; Liquidity; Business Cycle
41 pages, November 1, 2008
Full text files
uis_wps_2009_1_nas_skjeltorp_odegaard.pdf
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