How do volatility regimes affect the pricing of quality and liquidity in the stock market?

Tarik Bazgour; Cedric Heuchenne; Georges Hübner; Danielle Sougné

doi:10.1515/snde-2018-0127

Abstract

This paper shows how stock market volatility regimes affect the cross-section of stock returns along quality and liquidity dimensions. We find that, during crisis periods, low quality and low liquidity stocks experience relatively higher losses than predicted in normal times, while high quality and high liquidity stocks experience rather relatively lower losses. These findings lend strong support to the presence of cross-market and within-market flight-to-quality and to-liquidity episodes during crisis periods. During low volatility periods, however, low quality and low liquidity stocks earn relatively larger returns, while high quality and high liquidity stocks yield lower returns; suggesting that low volatility conditions benefit junk and illiquid stocks but not quality and liquid stocks. Finally, our results reveal that liquidity level dominates liquidity beta in explaining stock returns across the different market volatility regimes.

Keywords: financial crises; liquidity; liquidity risk; quality; volatility regimes

JEL Classification: G12; G32

Acknowledgement

We would like to thank the editor and anonymous referees for their helpful comments. We also thank Mikael Petitjean, Ines chaieb, as well as participants to the 2015 European Financial Management Association (EFMA) Conference and the 2018 International Conference of the French Finance Association (AFFI) for providing useful comments and suggestions. Any remaining errors are the responsibility of the authors.

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Published Online: 2019-11-22

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