Tuesday, January 12, 2010
Posted by D. Daniel Sokol
Jayant R. Kale, Georgia State University and Yee Cheng Loon, SUNY - Binghamton analyze Product Market Power and Stock Market Liquidity.
ABSTRACT: Theory predicts that since a firm with market power has more stable cash flows because of its ability to set prices in the product market, its stock price is less sensitive to order flow (Peress, 2009), which results in greater stock liquidity. We test this prediction on a large sample of firms and find that stock liquidity increases with market power because market power reduces return volatility. Further, consistent with theoretical predictions, the impact of market power on liquidity is more pronounced when information asymmetry is more severe, that is, for smaller firms and for firms with less analyst coverage. Our findings are robust to different measures of liquidity, market power, volatility, and alternative econometric model specifications.