Does the uncertainty of firm-level fundamentals help explain cross-sectional differences in liquidity commonality?

Our goal is to better understand the economic sources of commonality in liquidity. To this end, we argue that a firm with low (high) volatility in its “fundamental” profitability will have a higher (lower) liquidity commonality because it is more (less) likely to serve as reference stock in the setting of cross-asset learning about fundamentals. As predicted, we find that commonality in liquidity is negatively related to profitability volatility. This negative relation holds after controlling for correlated trading, size, book-to-market effects, idiosyncratic volatility, stock returns, and managerial income smoothing.