Liquidity, Price Behavior and Market-Related Events

In this research, I investigate price behavior of stock market portfolios sorted by liquidity and/or size surrounding market-related events. Three liquidity measures are used (Amihud illiquidity measure, turnover and adjusted ILLIQ). Amihud illiquidity measure is the ratio between the absolute value of the daily stock return and the daily dollar trading volume. Turnover is measured by the ratio between the daily trading volume and the shares outstanding. Adjusted ILLIQ is based on Amihud illiquidity measure, considering the non-trading effect on stock liquidity. I also sort the portfolios by size (measured by market capitalization). The outcomes suggest that large, liquid stocks react in a stronger manner and faster to market-related shocks---they also experience a faster reversal following the shocks than do illiquid and small stocks. My hypothesis is that large liquid stocks are more market related (with betas closer to or larger than one) while small illiquid firms tend to not be strongly market related (betas of less than one). The findings support this view. Additionally, I find that small illiquid stocks have more idiosyncratic risk (as measured by the variance of the error term) than liquid and large stocks. Overall, the results suggest that size and liquidity seem to identify the market relatedness of firms.