No one wants to get stuck with an unsellable stock. But are there ways to gauge a stock’s liquidity risk?
An important indicator might be whether the business has a country versus a city address.
Finance professors Tim Loughran and Paul Schultz present compelling evidence in a study published in the Journal of Financial Economics that, even after adjusting for size and other factors, stocks of companies located in remote, rural areas have less liquidity than those of urban companies located in the 10 largest U.S. cities.
As a result, country living comes at a cost. The study, which analyzed the daily stock turnover rates of nearly 2,000 companies from 1983 to 2002, found shares of urban stocks turned over 50 percent more rapidly than rural stocks.
The rural stocks also are covered by fewer analysts, are owned by fewer institutions and incur higher costs when traded on the Nasdaq.
In part, because investors like the familiar, which tends to be what is nearby. “Our urban stocks are based in cities with many investors,” said Loughran and Schultz in the study. “They are thus ‘local stocks’ for many people and familiar to many potential investors.”
To learn more about the stock liquidity of urban versus rural firms, visit the Web site of Tim Loughran, professor of finance at Mendoza College of Business, at business.nd.edu/timothyloughran.