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Stock Market Liquidity and the Business Cycle





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    • Randi Næs is at the Norwegian Ministry of Trade and Industry. Johannes A. Skjeltorp is at Norges Bank (the Central Bank of Norway). Bernt Arne Ødegaard is at the University of Stavanger, Norges Bank, and Norwegian School of Management. We are grateful for comments from an anonymous referee, an associate editor, and our Editor (Campbell Harvey). We also thank Kristian Miltersen, Luis Viceira, and seminar participants at the fourth Annual Central Bank Workshop on the Microstructure of Financial Markets in Hong Kong, Norges Bank, the Norwegian School of Economics and Business Administration, Statistics Norway (SSB), Center for Research in Economics and Statistics, and the Universities of Oslo, Stavanger, and Aarhus for comments. Ødegaard 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 recent financial crisis we saw 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 investors' portfolio compositions 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 a new explanation for the observed commonality in liquidity.