Mar. 17 2016 — Most investors do not associate stock-level liquidity as a stock selection signal, but as a measure of how easily a trade can be executed without incurring a large transaction cost or adverse price impact. Inspired by recent literature, such as Bali, Peng, Shen and Tang (2012), we show globally that a strategy of buying stocks with the highest one-year change in stock-level turnover has historically outperformed the market and has outperformed strategies of buying stocks with strong price momentum, attractive valuation, or high quality. One-year change in stock-level turnover has a low correlation (i.e., <0.15) with commonly used stock selection signals. When it is combined with these signals, the composites have yielded higher excess returns and information ratios (IR) than the standalone raw signals.
- In the U.S., a strategy of buying stocks with the highest one-year change in turnover outperformed the market and outperformed strategies of buying stocks with attractive valuation, strong price momentum, or high quality by 4.73%, 0.66%, 1.44% and 2.03% per year, respectively.
- One-year change in stock-level liquidity has low correlations (<0.15) with commonly used investment strategies. When it is added to the mix, the composites have produced higher excess returns and IRs.
- One-year change in turnover has produced excess returns after controlling for market, size, value, and price momentum and is not driven by variations in liquidity beta.
- Our results indicate change in turnover works due to investors’ underreaction.
Stock-Level Liquidity – Alpha or Risk?
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