Liquidity and the Business Cycle

We document a strong relation between stock market liquidity and the businesscycle. Stock market liquidity worsens when the economy is slowing down, and thiseffect is most pronounced for small firms. Using data for both the US and Norway,we show that stock market liquidity predicts the current and future state ofthe economy both in- and out-of-sample. We also show some evidence that canshed light on the link between stock markets and the real economy. Using stockownership data from Norway, we found that the portfolio compositions of investorschange with the business cycle, and that investor participation is correlated withmarket liquidity, especially for the smallest firms...