Economic Valuation of Liquidity Timing
Erasmus University Rotterdam; Tinbergen Institute
RSM Erasmus University; Duisenberg School of Finance
Wing Wah Tham
Erasmus School of Economics - Econometric Institute
Michel Van der Wel
Erasmus University Rotterdam; CREATES; ERIM; Tinbergen Institute
July 1, 2013
Journal of Banking and Finance, 37, p5073-5087
This paper provides a comprehensive economic evaluation of the short-horizon predictive ability of liquidity on monthly stock returns, using dynamic asset allocation strategies. We assess the economic value of the out-of-sample power of empirical models based on different liquidity measures and find three key results: liquidity timing leads to tangible economic gains; a risk-averse investor will pay a high performance fee to switch from a dynamic portfolio strategy based on various liquidity measures to one that conditions on the Zeros measure (Lesmond, Ogden, and Trzcinka, 1999); the Zeros measure outperforms other liquidity measures because of its robustness in extreme market conditions. These findings are stable over time and robust to controlling for existing market return predictors or considering risk-adjusted returns.
Number of Pages in PDF File: 46
Keywords: liquidity, forecasting, expected returns, economic valuation
JEL Classification: G11, G12, G17
Date posted: February 28, 2013 ; Last revised: August 5, 2014
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