Does Public News Alleviate The Market’s Underreaction to Liquidity Shocks?
Dong, Mengming Michael
Submission to the Friends of Fondren Library Research Awards, 2018. This paper was originally prepared for Course 2017 Fall: Third-year paper (required by the program), given by Professor Gustavo Grullon, Department of Finance.
There is evidence that equity markets underreact to liquidity shocks. In this paper, I examine whether the presence of public news mitigates such underreaction. I use comprehensive news data and find that when there is important public news in the same months of the liquidity shocks, the price discovery process of liquidity shocks does not get any faster. In certain tests, the drift is actually significantly larger. This shows that even though public news reveals more information to investors and draws more investor attention, it does not help investors incorporate liquidity shocks into prices. If anything, public news only aggravates market’s underreaction to liquidity shocks. Liquidity level overall is difficult for average investors to grasp.