Trading Volume Liquidity and Investment Styles
28 Pages Posted: 24 Dec 2007
Date Written: December 20, 2007
The purpose of this study is to better understand stock market trading volume liquidity, measured at the individual stock level, and its relationship with and potential impact on stock performance for a variety of well-known investment styles. We focus on two universes of generally liquid stocks (chosen because they are a primary focus of U.S. institutional investors such as mutual fund managers and pension fund managers), the stocks that make up the Standard & Poor's (S&P) 500 Index, and a broader index of the top 1,000 stocks measured by market capitalization (closely mimicking the Russell 1000 Index stocks). We show that three liquidity-related measures - trailing 3-month trading volume (i.e., shares), dollar value of trading volume, and turnover - are monotonically related to price-to-book (PB) and market capitalization (MKT), and momentum strategies based on both past 6-month "winners" and "losers" (MOM) tend to experience higher liquidity. When we sort stocks based on each of these liquidity measures we find that the more liquid stocks based on trading volume and turnover tend to have higher subsequent returns (1 through 12-month holding periods) than the less liquid stocks, although the reverse is true based on dollar volume. We then focus on the trading volume measure (which produces the greatest dispersion of returns) and run CAPM and Fama-French (3-factor and 4-factor) model regressions that show that the most heavily traded quintile of stocks experiences significant superior performance. We create a new measure that we call the trading volume factor, in the spirit of the Fama-French factors, and investigate its properties. We find that its beta is generally significant when added to the Fama-French 4-factor model, regressed against portfolio quintile returns based on PB, MKT and MOM sorts.
Keywords: Trading Volume, Liquidity, Investment Styles, Factors, Asset Pricing
JEL Classification: G11, G12, G23
Suggested Citation: Suggested Citation