Illiquidity and Stock Returns – II: Cross-Section and Time-Series Effects

34 Pages Posted: 19 Mar 2018

See all articles by Yakov Amihud

Yakov Amihud

New York University - Stern School of Business

Joonki Noh

Case Western Reserve University - Department of Banking and Finance

Date Written: March 12, 2018

Abstract

Lou and Shu (Review of Financial Studies, 2017) decompose Amihud’s (2002) illiquidity measure (ILLIQ) into two terms and claim that the average of inverse dollar trading volume (IDVOL) is sufficient to explain the cross-section of expected returns. We show two problems with their analysis. First, it hinges on an error in decomposing ILLIQ. They omit a term related to the covariance between volatility and trading volume which we show has significant effects on both the cross-section of expected stock returns and on the time-series of realized market returns. Second, the market IDVOL performs much worse than market ILLIQ in explaining the effect of illiquidity shocks on the time-series of realized market returns. IDVOL is also shown to incorrectly depict the liquidity crises of 1987 and 2008 while ILLIQ depicts them correctly.

Keywords: Illiquidity, Stock Returns, Cross-Section, Time-Series, Trading Volume

Suggested Citation

Amihud, Yakov and Noh, Joonki, Illiquidity and Stock Returns – II: Cross-Section and Time-Series Effects (March 12, 2018). Available at SSRN: https://ssrn.com/abstract=3139180 or http://dx.doi.org/10.2139/ssrn.3139180

Yakov Amihud

New York University - Stern School of Business ( email )

44 West 4th Street
Suite 9-190
New York, NY 10012-1126
United States
212-998-0720 (Phone)
212-995-4233 (Fax)

Joonki Noh (Contact Author)

Case Western Reserve University - Department of Banking and Finance ( email )

10900 Euclid Ave.
Cleveland, OH 44106-7235
United States
216-368-3737 (Phone)

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