Liquidity Characteristics of Market Anomalies and Institutional Trading
64 Pages Posted: 14 Dec 2020 Last revised: 26 May 2021
Date Written: December 31, 2020
This study examines the liquidity characteristics of market anomalies and how liquidity affects institutional trading on those anomalies. We find that long-short portfolios based on market anomalies have pervasive liquidity exposures. For long-horizon anomalies, the long legs of the portfolios are less liquid and suffer from deteriorating liquidity relative to the short legs. Short-horizon anomaly portfolios exhibit the opposite pattern. Consistent with such liquidity characteristics and institutional liquidity preference, aggregate institutional trades appear to be in the right direction for short-horizon anomalies but in the wrong direction for long-horizon anomalies. Perverse institutional trading on long-horizon anomalies disappears after we control for liquidity. We further find that liquidity-driven and non-liquidity components of institutional trades have different impact on market mispricing. The magnitude of long-horizon anomalies is exacerbated by the liquidity-driven institutional trading when such trading is in the wrong direction, but not affected by the direction of the non-liquidity component of institutional trading.
Keywords: Institutional trading, market anomalies, liquidity characteristics, market efficiency
JEL Classification: G10, G14, G23
Suggested Citation: Suggested Citation