INTERNATIONAL EVIDENCE ON THE EFFECT OF ECONOMIC POLICY UNCERTAINTY ON STOCK MARKET LIQUIDITY

Abstract

In this dissertation, I investigate the impact of economic policy uncertainty on stock market liquidity across a broad cross-section of countries. My dissertation is composed of three distinct yet related essays. My first essay examines the impact of economic policy uncertainty on stock liquidity and various firm-level cross-sectional variables explaining the uncertainty-liquidity relationship. The focus of the second essay, using a sample for non-U.S. stocks cross-listed in the U.S., is to examine the role of cross-listing in moderating the above impact. In the third essay, I examine the market liquidity and country-level factors that explain the relationship between economic policy uncertainty and market liquidity. In the first essay, I investigate the impact of economic policy uncertainty on stock liquidity using an international sample of twenty-four countries spanning a period of twenty-three years. The sample countries include fourteen developed and ten emerging countries. In this essay, I initially provide global evidence on the adverse impact of economic policy uncertainty (EPU) on stock liquidity. The result holds for all the countries in the sample except Croatia and Russia. Subsequently, I investigate the role of firms' information environment in explaining the uncertainty-liquidity relationship. Considering informational transparency and quality of information as two aspects of the information environment, I find that firm-level informational transparency plays a significant role in mitigating EPU's effect on stock liquidity, whereas the quality of information does not. In the second essay, I investigate whether cross-listing a non-U.S. stock in the U.S. reduces the detrimental impact of EPU on the liquidity of that stock. My sample of cross-listed stocks includes the stocks from twenty countries, cross-listed in the U.S. In this essay, I first examine how domestic and U.S. EPUs affect the domestic liquidity of cross-listed stocks relative to their non-cross-listed domestic counterparts. Based on the findings, I document that cross-listing helps mitigate the negative impact of economic policy uncertainty on stock liquidity—literature on cross-listing and liquidity documents that the impact of cross-listing on liquidity is contingent upon country characteristics. Using further analysis, I show that the role of cross-listing in mitigating the negative impact of EPU on domestic liquidity is contingent on home country characteristics. I provide evidence that cross-listing helps mitigate the negative impact for the stocks of developed strong governance countries but not for stocks of emerging and weak governance countries. The role of cross-listing in moderating the relationship between EPU and liquidity is stronger for common law countries relative to civil law countries. In the third essay, I examine the impact of economic policy uncertainty on stock market liquidity. Using a broad sample of twenty-four countries, I focus on the country-level characteristics that affect the EPU-liquidity relationship. Specifically, I study the role of market segmentation, financial development, funding constraint, and the country's governance structure in shaping the above relationship. I find that a country’s financial development and its governance mechanism help mitigate EPU's negative effect on stock market liquidity. However, market integration, as captured through trade openness and political stability, worsens the impact.