Abstract
Market microstructure research has documented the widespread existence of commonality in liquidity, although it is only beginning to identify its underlying causes. In addition to firm size and industry determinants, there is evidence of commonality for the stock portfolios traded by specialist firms on the NYSE. The purpose of this study is to show that equity index inclusion is a significant source of commonality. We hypothesize that the market behavior of arbitragers and fund managers increases the co-variation of liquidity through their block purchases and sales. Our empirical results are consistently supportive of the index inclusion hypothesis. The primary contribution of the study is to add index inclusion to the growing list of factors determining commonality in liquidity.
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