Essays on the Liquidity and Return Commonalities

This thesis investigates the liquidity commonality and the return commonality in the U.S. market using data from the New York Stock Exchange (NYSE). The liquidity commonality is defined as the covariance or co-movement of the individual stock liquidity with the market liquidity. The return commonality is defined as the covariance or co-movement of the individual stock return with the market return. I use the R2 to measure the market-wide return commonality, the market-wide liquidity commonality, and the industry-wide liquidity commonality.

This thesis consists of 5 chapters. Chapter 1 is the introduction of the thesis. Chapter 2 to Chapter 4 are the three main chapters of this thesis, which cover the U.S. stock markets. Chapter 5 is the conclusion of the thesis.

Chapter 1 presents a brief introduction to liquidity commonality and the three research questions covered in this thesis.

Chapter 2 discusses the importance of the industry liquidity commonality. I use Amihud’s (2002) illiquidity measure for liquidity and the R2 to measure the commonality in liquidity. I control for the market-wide liquidity commonality and estimate the industry-wide liquidity commonality, which is only specific to the industry. I show that the industry-wide liquidity commonality after controlling for the market is as important as the market-wide liquidity commonality. I also find that this industry-wide liquidity commonality increases when there are stock market declines. I find a significantly negative relationship between the industry liquidity commonality and the stock market returns.

Chapter 3 investigates the relationship between the industry liquidity commonality and the business cycle. I find that the industry-wide liquidity commonality increases when the business cycle is in recession. I also find that the relationship concentrates on industries with high external finance dependence but not with low industry concentration.

Chapter 4 examines the impact of COVID-19 on the return commonality and liquidity commonality. I find a positive and significant relationship between COVID-19 and the market return commonality. In addition, I show a positive and significant relationship between COVID-19 and the market liquidity commonality. However, I document that although there is a positive relationship between COVID- 19 and the industry liquidity commonality, it is insignificant. Using firm size as a proxy for investor type, I document that the relationship between market return commonality and the COVID-19 period concentrates more on small-size firms. On the other hand, it is unclear how the impact of the COVID-19 pandemic on market liquidity commonality differs across small-size firms and big-size firms.

Chapter 5 summarizes the findings of the three chapters and concludes the thesis.