Common Effects in Imbalances and Returns: Style-Based Comovement and Flight-to-Quality

Abstract

This paper examines common effects in monthly imbalances for New York Stock Exchange stocks over the period 1988 through 2004. Order imbalances for both individual stocks and portfolios display size and book-to-market based commonality that transcends marketwide effects. The three common factors in imbalances account for more than one-third of the explanatory power of the three-factor model of Fama and French (1993) and display predictable variation over the business cycle. Specifically, an improvement (deterioration) in economic conditions is associated with an increase (decline) in buying pressure for stocks in general, with the effects being stronger for small stocks than big stocks and for value stocks than growth stocks. These results are consistent with flight-to-quality patterns in trading and support a state variable interpretation of the size and value premiums in returns.

Keywords: Order Imbalance, Order Flow, Comovement, Business Conditions