Global Financial Crisis, Liquidity Shocks and Global Financial Stability

Abstract

The most recent global financial crisis, characterized as a liquidity crunch, began in the U.S. in late 2007 and quickly spread to other countries. The rapid propagation of the liquidity shock and the severe effects of the crisis on stock market performance have raised several important questions. Which channels contributed to the transmission of liquidity shocks? Why were some stocks with similar characteristics and degrees of exposure to a market-wide shock more dramatically affected during the crisis? While the crisis could have spread through several channels such as trade dependence among firms and markets, there are reasons to believe that institutional investors played an important role in transmitting the shock across assets and countries. Using comprehensive data on international institutional ownership and global intraday stock transactions for 17,493 stocks across 41 countries, this study investigates the role of institutional investors in spreading the market liquidity shock during the global financial crisis. We document that stocks with high pre-crisis institutional ownership significantly underperformed during the crisis period and, more importantly, that this effect is detrimental to stocks with greater exposure to the market liquidity shock. This result suggests that institutional investors played a significant role in propagating the liquidity shock during the financial crisis. Further analysis reveals that the spread of the liquidity shock by institutional investors clusters on the non-block and/or independent institutional investors, who were more likely to face liquidity constraints during the crisis.