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Stock Liquidity and Stock Price Crash Risk

Published online by Cambridge University Press:  25 July 2017

Xin Chang ,
Yangyang Chen  and
Leon Zolotoy
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Abstract

We find that stock liquidity increases stock price crash risk. To identify the causal effect, we use the decimalization of stock trading as an exogenous shock to liquidity. This effect is increasing in a firm’s ownership by transient investors and nonblockholders. Liquid firms have a higher likelihood of future bad earnings news releases, which are accompanied by greater selling by transient investors, but not blockholders. Our results suggest that liquidity induces managers to withhold bad news, fearing that its disclosure will lead to selling by transient investors. Eventually, accumulated bad news is released all at once, causing a crash.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 52 , Issue 4 , August 2017 , pp. 1605 - 1637
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2017 

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Footnotes

1

We thank Michael Chng, Ning Gong, Jarrad Harford, Elaine Hutson, John Lyon, Mark Maffett, Spencer Martin, Nadia Massoud, participants of the 2014 Auckland Finance Meeting and the 2015 Macquarie Global Quantitative Research Conference, and seminar participants at Deakin University, Monash University, the University of Adelaide, and the University of Melbourne. We are especially grateful to Hendrik Bessembinder (the editor) and two anonymous referees for the insightful comments and suggestions that have significantly improved the paper. We are also grateful to Hans Stoll and Christoph Schenzler of Vanderbilt University for providing the relative effective spread data, Brian Bushee for sharing the institutional investor classification data, and Fotis Grigoris for excellent research assistance.

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