Stock market liquidity and O/N LIBOR rates: A study for PIGS countries and Turkey

Abstract

During the mortgage crisis in 2008 there was a significant demand increase in the LIBOR market due to the shrinkage in commercial paper market and liquidity crunch. This study examines the relationship of stock market price movements and liquidity with the overnight LIBOR rates for PIGS countries and Turkey. In the first section of empirical analysis we determined the stationary levels of data and tested long term relationship through Maki (2012) cointegration test with structural breaks. Following the verification of the relationship between stock market liquidity and overnight LIBOR rates, we conducted Fully Modified OLS, Canonical Cointegrating Regression and Dynamics Least Squares tests to estimate the parameter of LIBOR variable and identify the direction of relationship. This parameter was only significant for the Turkish and Spanish stock markets and the sign of this parameter was negative. Results showed that when the overnight LIBOR rates increased, the bid-ask spreads of the Turkish and Spanish markets expand indicating a decrease in liquidity of the market. A possible reason for this finding was the decoupling process of Turkey and Spain, especially during the mortgage crisis. EU defined debt stock/GDP ratios also supported that explanation. © 2015, Mediterranean Center of Social and Educational Research. All rights reserved.