The Behavior of Stock Returns during Liquidity Crisis

Market liquidity is a precondition for market efficiency but its sudden disappearance may escalate into a systemic crisis. Several studies analyzing financial crises revealed that market illiquidity was often involved in the major global financial crises and stock crashes. Liquidity is a Multidimensional concept. This research focuses on market illiquidity that is reflected by temporary price deviations caused by the order flow, i.e. the price impact. The objective of this research is to study the relationship over time between returns and shocks in market illiquidity. For empirical evidence, this relationship is studied using data of Small and Medium-sized Enterprises (SMEs) listed on the Saudi stock exchange. Saudi SMEs attracts considerable attention since they allow diversification of Saudi economy. Stock prices has been examined which could be affected by illiquidity shocks and whether this effect varies according to the enterprise size has been tested. Estimation of shocks in market illiquidity is based on the measure of amid at weekly frequency. Results show that shocks in market illiquidity significantly lower contemporaneous stock prices of Saudi SMEs, except those of the “Real estate management and development” sector