Does Exposure to Foreign Competition Affect Stock Liquidity? Evidence from Industry-Level Import Data

Abstract

We examine the effect of trade liberalization on stock markets, and find a negative association between foreign competition and stock liquidity. Our results hold using an instrumental variable methodology and in a quasi-natural experiment setting. We identify a deterioration in the informational environment in response to increases in foreign competition, as the channel through which foreign competition affects stock liquidity. Specifically, we find that the negative effect that foreign competition has on stock liquidity is less evident amongst better monitored firms and firms with greater analyst coverage. Our paper is the first to highlight the unintended consequences of trade liberalisation on financial markets.