The exposure to illiquidity of stocks - a study of the determinants with a focus on the 2007-2009 financial crisis

Abstract: This paper investigates the determinants of stocks' exposure to illiquidity in the US stock market. The periods that are examined are the financial crisis of 2007-2009 and the non-crisis period of 2005-2007. We find that the significant determinants of stocks' exposure to illiquidity in the non-crisis period are the historical and current illiquidity level of the stock, the goodwill to assets ratio of the underlying firm and, to some extent, the sector that the stock belongs to. However, in the crisis period, risk measures become more important. In fact, in addition to the current illiquidity level of the stock and, to some extent, the sector that the stock belongs to, the standard deviation of stock returns, leverage, interest coverage ratio and firm size become significant determinants. These findings are in line with our hypotheses that the flight to quality dynamics during the crisis cause stocks of risky firms to be more exposed to illiquidity, everything else equal. The results furthermore indicate that investors do not anticipate the flight to quality dynamics when trading stocks in the non-crisis periods, since none of the risk measures are significant in the non-crisis period.