Abstract
Using a unique research design, this paper examines how the level of trust in various countries affects liquidity in financial markets. In particular, we examine various measures of market liquidity in American Depositary Receipts (ADRs) while conditioning on the level of trust in the ADR’s home country, which we approximate with perceived corruption and the level of interpersonal trust. Multivariate tests show that as home-country levels of trust increase, ADR liquidity is dramatically improved. To draw stronger causal inferences, we use a difference-in-difference approach to examine liquidity surrounding an (arguably) exogenous reduction in trust and find that liquidity worsens in response to the event. These results support our hypothesis that trust is an important determinant in the liquidity of financial markets.
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