(The Relationship between Liquidity and Return Volatility in the Stock Market: The Case of Borsa İstanbul)

Abstract

Purpose – The aim of this study is to empirically analyze the existence and direction of the relationship between liquidity and return volatility in Borsa İstanbul for the period of January 2008 - August 2019 using different liquidity measures. Design/methodology/approach – The relationship between liquidity level and return volatility is investigated under VAR model by using Granger (1969) causality test and generalized impulse response analysis. In this context, three liquidity measures are formed in order to represent liquidity: high-low range, Amihud illiquidity measure and volatility over volume ratio. Return volatility is estimated by GARCH (1,1) model. Findings – The findings reveal a bi-directional Granger causality relationship between all liquidity measures and the return volatility for Borsa İstanbul. Impulse response analyses show that a shock to the liquidity level increases the return volatility rapidly and this effect is long lasting. On the other hand, the findings suggest that a shock to return volatility reduces the liquidity level, but the response is less than the return volatility gives to the liquidity level. Discussion – The study supports firms and policy makers to take measures to increase liquidity. In this context, it would be useful to focus on the determinants of liquidity in the future studies.