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 ” 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

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

14 Sample: 37 Stock Markets Europe Austria Belgium France Germany Italy Portugal Switzerland UK SE. Asia HK Indonesia Japan Korea Malaysia Philippine Singapore Taiwan Thailand Latin Argentina Chile Colombia Mexico Peru Venezuela E.Europe Czech Poland Russia? Turkey? Scandinavian Denmark Finland Norway Sweden Others Australia China India Israel South Africa

15 Illiquidity Measure 1

16 Illiquidity Measure 2

17 Illiquidity Measure 3

18 Regional Illiquidity Measures (Mean)

19 Illiquidity Measures (Mean) by Legal Origin

20 Rank correlation Volatility of economic variables

21 Rank correlation Market Characteristics & Economic variables

22 Rank correlation Legal variables

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

24 Regional Illiquidity Measures

25 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)

26 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

27 Legal Origin and Corporate Governance English(10): USA, UK, South Africa, Australia, HK French(14): Argentina, Belgium, France, Italy German(9): Austria, German, Japan, Switzerland Scandinavian(4): Denmark, Finland, Norway, Sweden

28 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