Liquidity and Autocorrelations in Individual Stock Returns
Hebrew University of Jerusalem - Jerusalem School of Business Administration
Emory University - Department of Finance
University of Lausanne; Ecole Polytechnique Fédérale de Lausanne - Swiss Finance Institute
January 12, 2005
This paper documents a strong relationship between short-run reversals and stock return illiquidity, even after controlling for trading volume. The largest reversals and the potential contrarian trading strategy profits occur in the high turnover, low liquidity stocks, as the price pressures caused by non-informational demands for immediacy are accommodated. Thus, the high frequency negative autocorrelations are more likely to result from stresses in the market for liquidity. The contrarian trading strategy profits are smaller than the likely transactions costs because the high turnover, low liquidity stocks face large transaction and market impact costs. This lack of profitability and the fact that the overall findings are consistent with rational equilibrium paradigms suggest that the violation of the efficient market hypothesis due to short-term reversals is not so egregious after all.
Number of Pages in PDF File: 41
Date posted: June 13, 2004