Liquidity and Firm Performance in Pakistan Stock Exchange

Abstract

The study is based on market microstructure theory. The study tested the hypothesis based on firm performance and market liquidity. Both variables were captured from the PSX listed firms which were randomly selected. The study incorporated annual observations. The dependent variable in this study is firm performance and independent is liquidity. Moreover, idiosyncratic risk has been introduced as a controlling variable. To capture the risk study uses CAPM model’s error term. We also used standard deviation of trading volume and standard deviation of turnover as independent variables. Our results indicate that the model based on Tobin’s Q and Amihud (2002) illiquidity proxy is best for prediction of relationship between firm performance and liquidity. Our findings suggested that the Tobin’s Q may be related with Amihud (2002) proxy. Moreover, the findings suggested that the relationship between firm performance and illiquidity is inverse. In lay man language, we can conclude this as the when the more liquid stock in the market performs better than the illiquid stocks. Because good news impacts the Pakistan Stock Exchange. Investors may prefer to trade in those stocks which are liquid in the stock market as well as the general public and investors prefer high performing firms. Means liquidity leads firms’ value. So, we cannot reject our null hypothesis. In Pakistan Stock Exchange, our other 2 liquidity proxies did not perform well. We also tried to find relationship with standard deviation of volume and standard deviation of turnover. Both proxies did not perform in our context. These proxies did not perform in the work of Rehman et. al. (2020). But these two proxies are not too much common as our main illiquidity measure is, therefore, the firm performance measured with Tobin’s Q is significantly associated with illiquidity.