Trade-Time Measures of Liquidity
The Review of Financial Studies (32)1, 126-179
67 Pages Posted: 20 Mar 2016 Last revised: 18 Dec 2020
Date Written: November 1, 2017
Dramatic microstructure changes in equity markets have made standard liquidity measures less accurate proxies of trading costs. We develop trade-time liquidity measures that reflect per-dollar price impacts of fixed-dollar volumes. Our measures (i) better capture institutional trading costs; and (ii) better explain the cross-section of returns than do standard measures, e.g., quoted and effective spreads, estimates of Kyle's λ, and Amihud's (2002) measure, especially in more recent years. Despite improvements in measures of market quality, expected trading costs still have explanatory power for the cross-section of expected returns for NYSE-listed stocks: we obtain monthly liquidity premium estimates of 5.3bp for expected returns and 2.4bp for risk-adjusted returns. Liquidity premiums rise after the financial crisis and remain consistently high thereafter.
Keywords: Liquidity, Trading costs, Trade time, Liquidity premium
JEL Classification: G12, G14
Suggested Citation: Suggested Citation