Freedom of choice impact on country-specific liquidity commonality

We use three facets of freedom of choice (opportunity, decisional autonomy, and immunity from interference) to develop a freedom of choice index for 46 countries and test its impact on commonality in liquidity. We find that the three aspects of individual freedom of choice are negatively related to country-specific market liquidity commonality. Building on Sen’s (1993) theoretical framework, we document that in the presence of opportunities for making independent choices, immunity from encroaching activities, and decisional autonomy, investors tend to show less correlated trading decisions, measured by the levels of liquidity co-movement. To address possible endogeneity bias, we use 9/11 and country-level terrorist attacks as an exogenous source of variations to personal freedom of choice. We find that higher levels of perceived threats in a country restrain personal freedoms and tend to reduce freedom of choice effects on liquidity commonality. Our results are robust to alternative explanations, freedom of choice definitions, and model specifications.