Predicting the Future with Stock Market Liquidity: A Study of the Swedish Stock Market Liquidity as a Leading Indicator of the Future Business Cycle

Abstract: Using daily stock data from the Stockholm Stock Exchange, this paper investigates the relationship between stock market liquidity and the real economy. We find restricted support for stock market liquidity containing leading information about real economic growth. Our results further document that stock market liquidity does not add significant explanatory value relative to asset prices and stock market volatility. By studying the recessions caused by the financial crisis in 2008 and the Covid-19 outbreak, we show that our model's performance is affected by the origin of the economic downturn examined. Inconsistent with the flight-to-liquidity phenomenon, we manifest that the liquidity of small firms does not have predictive power over large firms. Our research indicates that the forecasting performance of stock market liquidity varies as a consequence of the region, time period, and liquidity proxy employed.