Liquidity as an Investment Style
Yale University - International Center for Finance; Zebra Capital Management, LLC
Roger G. Ibbotson
Yale School of Management; Zebra Capital Management, LLC
affiliation not provided to SSRN
September 10, 2010
Yale SOM Working Paper
We first show that liquidity, as measured by stock turnover or trading volume, is an economically significant investment style that is distinct from traditional investment styles such as size, value/growth, and momentum. We then introduce and examine the performance of several portfolio strategies, including a Volume Weighted Strategy, an Earnings Weighted Strategy, an Earnings-Based Liquidity Strategy, and a Market Cap-Based Liquidity Strategy. Our backtest research shows that the Earnings-Based Liquidity Strategy offers the highest return and the best risk-return trade-off, while the Volume Weighted Strategy does the worst. The superior performance of the liquidity strategies are due to equilibrium, macro, and micro reasons. In equilibrium, liquid stocks sell at a liquidity premium and illiquid stocks sell at a liquidity discount. Investing in less liquid stocks thus pays. Second, at the macro level, the growing level of financialization of assets in the world makes today’s less liquid securities increasingly more liquid over time. Finally, at the micro level, the strategy avoids, or invests less, in popular, heavily traded glamour stocks and favors out-of-favor stocks, both of which tend to revert to more normal trading volume over time.
Number of Pages in PDF File: 31
Keywords: Liquidity, Stocks, Investment Style
JEL Classification: D40l, D46, G00, G10, G11, G12
Date posted: September 12, 2010 ; Last revised: September 15, 2010
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