Economic Valuation of Liquidity Timing

46 Pages Posted: 28 Feb 2013 Last revised: 5 Aug 2014

See all articles by Dennis Karstanje

Dennis Karstanje

Erasmus University Rotterdam; Tinbergen Institute

Elvira Sojli

UNSW Business School, School of Banking and Finance

Wing Wah Tham

University of New South Wales (UNSW)

Michel van der Wel

Erasmus University Rotterdam; CREATES; ERIM; Tinbergen Institute

Date Written: July 1, 2013

Abstract

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.

Keywords: liquidity, forecasting, expected returns, economic valuation

JEL Classification: G11, G12, G17

Suggested Citation

Karstanje, Dennis and Sojli, Elvira and Tham, Wing Wah and van der Wel, Michel, Economic Valuation of Liquidity Timing (July 1, 2013). Journal of Banking and Finance, 37, p5073-5087. Available at SSRN: https://ssrn.com/abstract=2225758 or http://dx.doi.org/10.2139/ssrn.2225758

Dennis Karstanje (Contact Author)

Erasmus University Rotterdam ( email )

HOME PAGE: http://www.karstanje.com

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Elvira Sojli

UNSW Business School, School of Banking and Finance ( email )

Sydney, NSW 2052
Australia

HOME PAGE: http://sites.google.com/site/esojli/

Wing Wah Tham

University of New South Wales (UNSW)

Kensington
High St
Sydney, NSW 2052
Australia

Michel Van der Wel

Erasmus University Rotterdam ( email )

Burg. Oudlaan 50
Rotterdam, NL 3062 PA
Netherlands

CREATES ( email )

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

ERIM ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

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