Stock Price Synchronicity and Liquidity
38 Pages Posted: 18 Mar 2008 Last revised: 1 Jan 2013
Date Written: June 2012
Abstract
We provide a simple theoretical analysis based on Kyle's (1985) framework, and demonstrate how stock price synchronicity can affect the adverse information risk that market makers face and therefore the liquidity of the stock. Our empirical evidence is consistent with our theoretical conjecture. We find that stocks which co-move more with the market index have higher liquidity, computed based on effective spread, price impact or Amihud illiquidity measures. The results are obtained after controlling for cross-sectional differences in firm size, price levels, total and idiosyncratic volatilities, and are robust to both S&P and non S&P index stocks. Besides market co-movement, industry wide component in returns also reduces the adverse selection risk and improves the liquidity. We also find results related to indexing effect. Following the addition to the S&P 500, a firm that experiences an increase in co-movement with the market is more likely to be accompanied by an improvement in liquidity.
Keywords: Liquidity, Price Synchronicity, adverse information risk
JEL Classification: L19
Suggested Citation: Suggested Citation
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