Charles A. Dice Center Working Paper No. 2016-19
62 Pages Posted: 7 Oct 2016 Last revised: 6 Nov 2016
Date Written: November 1, 2016
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: Suggested Citation