Impact of Policy Uncertainty on Stock Liquidity: Cross-sectional Effects and Economic Channels

Abstract

We document a negative impact of economic policy uncertainty on stock liquidity. This impact is stronger for firms with: (i) higher sensitivity of stock returns to economic policy uncertainty; (ii) higher level of political risk; and (iii) heavier dependence on government spending. We identify three underlying economic channels that influence the adverse impact of policy uncertainty on stock market liquidity: higher cash flow risk; greater information asymmetry problems; and lower funding liquidity. Overall, our findings highlight the significant role of economic policy uncertainty in determining secondary market liquidity.