In contrast with prior studies focused on market-wide liquidity co-movements, we study class-wide liquidity co-movements and condition the analysis on volatility regimes using the Markov switching methodology. By defining three regimes of volatility (low, normal and high), we can investigate whether, and to what extent, liquidity co-movements in cap-based portfolios are affected by volatility fluctuations. As our analysis points out, class-wide shocks dominate stock-specific shocks in low volatility regimes for both large and mid caps. For small caps, cross-sectional statistical evidence of liquidity co-movements is weak in both high and low volatility regimes. Evidence indicates that failure to recognise the importance of volatility to determine class-wide variations in liquidity could significantly alter the performance and risk of size-based portfolios.
- Empirical Analysis