Does monetary policy determine stock market liquidity? New evidence from the euro zone

The recent financial crisis has been characterized by unprecedented monetary policy interventions of central banks with the intention to stabilize financial markets and the real economy. This paper sheds light on the actual impact of monetary policy on stock liquidity and thereby addresses its role as a determinant of commonality in liquidity. Our results suggest that an expansionary monetary policy of the European Central Bank leads to an increase of aggregate stock market liquidity in the German, French and Italian markets. Furthermore, the effect of monetary policy is significantly stronger for smaller stocks, suggesting a non-linear impact of monetary policy on stock liquidity.

► ECB monetary policy determines stock liquidity in German, French and Italian markets. ► First empirical evidence for euro zone. ► The effect of monetary policy is significantly stronger for smaller stocks. ► Combination of panel and time series econometrics for a powerful and robust analysis. ► Application of widely recognized and new measures of liquidity and monetary policy.