The impact of policy responses on stock liquidity

Abstract

The collapse of Lehman Brothers in 2008 marked the peak of a financial crisis that is affecting the entire world of finance. This period is characterized by increasing fear of further defaults by corporations (including banks) or even by countries. In reaction, investors began shifting their assets to more stable and secure investments and this resulted in stock market crashes. Various policy interventions were initiated to restore stability. In this article, we analyse the impact of these interventions on stock liquidity, proxied by a new liquidity measure. The interventions, which we consider, are published by the Federal Reserve Bank (FED) in the form of a crisis timeline. Here, they are further combined to the following categories: bank liability guarantees, liquidity and rescue interventions, unconventional monetary policy and other market interventions. The results indicate that the market reacts positively to liquidity and rescue interventions, whereas bank liability guarantees reduced stock liquidity. In addition, we show that international events have a significant impact on the domestic market. By analysing the spreads of different trading volumes, an asymmetric effect can be detected, where the impact on lower trading volumes is substantially more pronounced compared to higher trading volumes.

Keywords:

• policy interventions
• stock liquidity
• flight-to-liquidity
• GARCH
• XLM

JEL Classification:

• G13
• G14

Notes

¹ The SoFFin (Sonderfonds für Finanzmarktstabilisierung) was created in October 2008 to stabilize the financial system in Germany. The agency was able to grant guarantees and recapitalization. They were also authorized to establish their own resolution agencies under the protection of the federal agency for Financial Market Stabilization.

² The particular choice of the lags and the GARCH specification was motivated by the underlying spread data.

³ See http://www.newyorkfed.org/research/global_economy/policyresponses.html, Aït-Sahalia et al. (2012) and Beber and Pagano (2013) for details.