Effect of News Sentiment on LOB Liquidity

Abstract This research will attempt to illuminate the effect of news sentiment and schedule on the stock liquidity. Being one of the most crucial aspects in the financial markets, the liquidity implies a tight connection with the cost of capital for companies and the ability of investors to transact under lower information asymmetry. In current research, we consider bid and ask elasticities to measure the liquidity. This paper examines the effect of news sentiment in several dimensions and its timing with the emphasis on firm-specific news on liquidity. A sample of around 800 largest firms from NYSE for the period from 2008 to 2012 has been chosen for the study. The research documents fixed effects model with as well as GMM approach for robustness check. We examine the hypothesis that the liquidity for both supply and demand sides is positively affected by the tone of the news, that is the liquidity increases after the release of more positive news. We also question whether liquidity deteriorates for any news tone prior to the release if the timing of announcement is predetermined and increases after the release as the uncertainty is resolved. The estimation of the news sentiment, its schedule and liquidity can be applied both by companies’ managers and individual investors in order to understand the liquidity dynamics around news releases thus reducing the cost of capital and to predict the appropriate time for transactions. Keywords: liquidity, news sentiment, elasticity, announcements, panel data, information asymmetry.