TAILIEUCHUNG - Stock Market Liquidity and the Business Cycle

This section explores the effect of CEO compensation on firm risk. We have noted in Section I that the effect of an increase in firm risk on CEO’s wealth depends on how much of this wealth comes from stock options relative to other forms of compensation such as salary and stock holdings. For a CEO who cares about percentage changes in wealth rather than absolute changes in wealth, we can measure this effect through the total CEO wealth elasticity with respect to stock volatility. This variable captures the effect of volatility changes on the total wealth of the CEO, and not only on the value. | Stock Market Liquidity and the Business Cycle Randi Nms Johannes A. Skjeltorp and Bernt Arne 0degaard March 2010 Forthcoming Journal of Finance Abstract In the recent financial crisis we saw the liquidity in the stock market drying up as a precursor to the crisis in the real economy. We show that such effects are not new in fact we find a strong relation between stock market liquidity and the business cycle. We also show that the portfolio compositions of investors change with the business cycle and that investor participation is related to market liquidity. This suggests that systematic liquidity variation is related to a flight to quality during economic downturns. Overall our results provide an new explanation for the observed commonality in liquidity. Randi Nffis is at the Ministry of Trade and Industry. Email ran@. Johannes A Skjeltorp is at Norges Bank the Central Bank of Norway . Email . Bernt Arne 0degaard is at the University of Stavanger and Norges Bank. Email . We are grateful for comments from an anonymous referee associate editor and our editor Campbell Harvey . We also thank Kristian Miltersen Luis Viceira and seminar participants at the 4th Annual Central Bank Workshop on the Microstructure of Financial Markets in Hong Kong Norges Bank the Norwegian School of Economics and Business Administration NHH Statistics Norway SSB CREST and the Universities of Oslo Stavanger and Aarhus CREATES for comments. 0degaard acknowledges funding from Finansmarkedfondet The Finance Market Fund . The views expressed are those of the authors and should not be interpreted as reflecting those of Norges Bank or the Ministry of Trade and Industry. In the discussion of the current financial crisis much is made of the apparent causality between a decline in the liquidity of financial assets and the economic crisis. In this paper we show that such effects are not new changes in the liquidity of the US stock .

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