Liquidity and Conditional Heteroscedasticity in Stock Returns

31 Pages Posted: 8 Jun 2006

See all articles by Akiko Watanabe

Akiko Watanabe

University of Alberta - School of Business; University of Alberta - Department of Finance and Statistical Analysis

Masahiro Watanabe

University of Alberta - School of Business; University of Alberta - Department of Finance and Statistical Analysis

Abstract

This paper finds a significant positive relation between illiquidity and conditional variance of stock returns, both at the individual and aggregate levels. For each of the largest two hundred stocks on the NYSE and NASDAQ, we estimate a GARCH model in which share turnover and proportional spread enter the conditional variance equitation. We find that, for 75% of the stocks examined, proportional spread is a significant and positive determinant of conditional heteroscedasticity after orthogonalization against share turnover and return. Alternative measures of illiquidity also have a strong positive effect on the variability of aggregate market return. In support of these findings, we present a simple market microstructural model in which conditional return variance is a positive and nonlinear function of stochastic Kyle's lambda.

Keywords: liquidity, volume and conditional heteroscedasticity, GARCH models, stochastic Kyle's lambda

JEL Classification: G14, D82

Suggested Citation

Watanabe, Akiko and Watanabe, Masahiro, Liquidity and Conditional Heteroscedasticity in Stock Returns. EFA 2006 Meetings Paper. Available at SSRN: https://ssrn.com/abstract=906327 or http://dx.doi.org/10.2139/ssrn.906327

Akiko Watanabe

University of Alberta - School of Business ( email )

3-30A Business Building
University of Alberta
Edmonton, Alberta T6G 2R6
Canada
780-492-0385 (Phone)
780-492-3325 (Fax)

HOME PAGE: http://www.bus.ualberta.ca/awatanabe

University of Alberta - Department of Finance and Statistical Analysis ( email )

2-32C Business Building
Edmonton, Alberta T6G 2R6
Canada

HOME PAGE: http://www.bus.ualberta.ca/awatanabe

Masahiro Watanabe (Contact Author)

University of Alberta - School of Business ( email )

School of Business - FMS
University of Alberta
Edmonton, Alberta T6G 2R6
Canada
780-492-7343 (Phone)
780-492-3325 (Fax)

HOME PAGE: http://www.ualberta.ca/~masa/

University of Alberta - Department of Finance and Statistical Analysis ( email )

2-32C Business Building
Edmonton, Alberta T6G 2R6
Canada

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