Essays in market liquidity and financial crises/capital controls

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This dissertation is composed of two essays. In the first essay, we investigate whether contagion during a financial crisis is associated with a market liquidity contagion. We employ two market liquidity measures, i.e. turnover ratio and trading volume. We adopt the correlation approach to test for contagion during the Thai crisis, the Hong Kong crisis, the Russian crisis, and the Brazilian crisis. Evidence of market liquidity contagion is mostly found during the Hong Kong crisis and the Russian crisis. Our results are not sensitive to the two measures used, and also to the heteroskedasticity-corrected technique. We also do not find much support for the notion that market liquidity level is lower during a crisis period, as predicted by the contagion literature. However, we do find some evidence of higher variability of market liquidity during a crisis, especially during the Hong Kong crisis and the Russian crisis. In the second essay, we examine the relation between market liquidity and stock returns in the Malaysian stock market (KLSE), and whether this relation is altered by capital control measures implemented by the Malaysian government in September 1998. Our findings indicate that the state of market liquidity measures pre- and post-capital controls are consistent with the financial market de-liberalization implications. In particular, the average means are lower for turnover ratio and turnover-volatility ratio post-capital controls. On the cross-sectional relation between liquidity and stock returns on KLSE, we find that turnover ratio and turnover-volatility ratio are negatively and significantly related to stock returns. On the effect of capital controls on the relation, we find significant shifts (i.e. higher) in the slopes of both turnover ratio and turnover-volatility ratio coefficients post-capital controls. Therefore, our study provides support for the critics of capital controls regarding the unfavorable impact of capital controls on market liquidity and its relation with stock returns on KLSE.

Emerging market, Financial contagion, Asset pricing