Abstract
We find that liquidity volatility negatively predicts stock returns in global markets. This relationship holds for different liquidity measures and cannot be explained by the idiosyncratic volatility effect. This puzzle can be explained by the asymmetric impact of liquidity increase and decrease on expected returns. Since the price decline following liquidity decrease outweighs the price appreciation after liquidity increase, high-liquidity-volatility stocks, which are more likely to experience large liquidity changes in either direction, tend to have negative returns on average. We find that including liquidity decrease explains the negative premium of liquidity volatility, while including liquidity increase does not.
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