(Priced) Frictions

Fisher College of Business Working Paper No. 2016-03-19

Charles A. Dice Center Working Paper No. 2016-19

62 Pages Posted: 7 Oct 2016 Last revised: 6 Nov 2016

See all articles by Kewei Hou

Kewei Hou

Ohio State University (OSU) - Department of Finance

Sehoon Kim

University of Florida - Department of Finance, Insurance and Real Estate

Ingrid M. Werner

The Ohio State University - Fisher College of Business

Date Written: November 1, 2016

Abstract

We propose a parsimonious measure based solely on daily stock returns to characterize the severity of microstructure frictions at the individual stock level and assess the impact of frictions on the cross section of stock returns. Stocks with the largest frictions command a value-weighted return premium as large as 10% per year on a risk-adjusted basis. The friction premium is stronger among small, low price, volatile, value, and illiquid stocks. Return spreads associated with momentum and idiosyncratic volatility are smaller and statistically less significant than previously documented after screening out stocks with high microstructure frictions. Using UK data, we show that our measure is useful in settings where the availability of quality data on trading volume, bid-ask prices, and intraday high-low prices is limited.

Keywords: Microstructure frictions, return measurement bias, asset pricing, and anomalies

JEL Classification: G10, G12, G14

Suggested Citation

Hou, Kewei and Kim, Sehoon and Werner, Ingrid M., (Priced) Frictions (November 1, 2016). Fisher College of Business Working Paper No. 2016-03-19. Available at SSRN: https://ssrn.com/abstract=2849080 or http://dx.doi.org/10.2139/ssrn.2849080

Kewei Hou

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
614-292-0552 (Phone)
614-292-2418 (Fax)

Sehoon Kim

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611
United States

Ingrid M. Werner (Contact Author)

The Ohio State University - Fisher College of Business ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
614-292-6460 (Phone)
614-292-2418 (Fax)

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