Illiquidity spillover: the cross-market impact of firm level illiquidity
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This study is an examination of the cross-market relations of illiquidity at the firm level. In the first part of the study I explore the cross-market pricing implications of the illiquidity of a firm's stocks and bonds. Using two illiquidity measures I test whether greater stock illiquidity impacts the same firm's bond returns and whether greater bond illiquidity impacts the same firm's equity returns. I find evidence that illiquidity is positively priced across markets. In the second section I look at whether illiquidity in one market impacts illiquidity in the other market. I find evidence that illiquidity from the bond market is correlated with illiquidity in the equity market for an individual firm's assets. Using Granger causality tests and impulse response functions I then find that greater illiquidity in one market is associated with greater illiquidity in the other market. These results are robust to the inclusion of controls including lagged returns from both markets. Taken together, evidence indicates the existence of an illiquidity linkage between a firm's equity and debt securities. The results in this paper offer important implications for asset pricing and understanding how markets are interconnected, and lead to a better understanding of illiquidity channels.
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