Market volatility and illiquidity during the COVID-19 outbreak: Evidence from the Saudi stock exchange through the wavelet coherence approaches

The aim of this paper is to examine the explanatory power of realized volatility on the illiquidity in Saudi stock market during the COVID-19 outbreak. To achieve this objective, we consider the Wavelet Coherence approaches as empirical tools to investigate the combined effect of realized volatility and COVID-19 counts on the market illiquidity across frequencies and over time space by taking in account the number of infected cases in Saudi Arabia and over the World, and the number of death cases in Saudi Arabia as well as over the World. Our study reaches two main findings. First, the preliminary results reported by the ARDL bound test as a benchmark model showed significant long-run and short-run effects of the market volatility on illiquidity in contemporaneous and lagged manner. Second, the wavelet coherence analysis tools exhibited important results: (i) the wavelet coherency between illiquidity ratio and realized volatility in Saudi Arabia appear highly pronounced over all time horizons. (ii) PWC plots showed a significant mutual effect between liquidity risk and realized volatility when eliminating the effect of local COVID-19 cases. (iii) MWC plots highlighted that the response of the market illiquidity index to both the amplification in confirmed local cases (resp. international confirmed cases) and the stock market volatility appear significant in the short and middle horizons.