Asset Liquidity and Stock Liquidity

We study the relation between the liquidity of the firm’s assets and the liquidity of financial claims on the assets, thereby linking corporate finance decisions to stock liquidity. Our model highlights an ambiguous relationship. While greater asset liquidity reduces uncertainty regarding valuation of assets-in-place, it increases future investments and the associated uncertainty. The model shows that asset liquidity improves stock liquidity more for firms which are less likely to reinvest their liquid assets, i.e., firms with less growth opportunities and financially constrained firms. Empirically, we find a positive and economically large relation between asset liquidity and stock liquidity. Consistent with our model, the relation is more positive for firms with low growth opportunities and for financially constrained firms. The relation between asset liquidity and stock liquidity that we uncover sheds new light on the importance of financial frictions for firm investment policy and on the value of holding liquid assets. ∗Radhakrishnan Gopalan ([email protected]) and Ohad Kadan ([email protected]) are with the Olin Business School at Washington Universtity in St. Louis. Mikhail Pevzner ([email protected]) is with the School of Management at George Mason University. We thank Joel Hasbrouck for graciously providing data on stock liquidity measures and Vanderbilt University’s Center for Research on Financial Markets for making available the data on bid-ask spreads. We are also grateful to Viral Acharya, Tarun Chordia, Paolo Fulghieri, Adriano Rampini, Ronnie Sadka, Mark Seasholes, and Avi Wohl and to seminar participants at Barclays Global Investors, European Finance Association meetings at Bergen and our discussant Erik Theissen, Financial Intermediation Research Society conference at Prague and our discussant Sugato Bhattacharya, Hong Kong University of Science and Technology, George Mason University, Nanyang Technological University, Singapore Management University, Microstructure conference at the Swiss National Bank and our discussant Gunther Wuyts, and Washington University for very helpful comments; and to Engin Kose and Anirudh Jonnavitula for assistance with data collection. 1