Morningstar Advisor - April/May 2013 - (Page 64)
Gray Matters
Liquidity Signals
By James X. Xiong, Rodney N. Sullivan, and Peng Wang
Incorporating market-liquidity levels in a dynamic asset-allocation
policy improves portfolios.
A longer version of this article will be published
in the 2013 summer issue of the Journal
of Portfolio Management.
At the micro-level, liquidity relates to the speed
and ease with which an investor can trade
an asset. Amihud and Mendelson (1986) used
the bid-ask spread as a measure of liquidity
to test the relationship between security
returns and liquidity. They found evidence that
investors demanded a premium for illiquid
securities. Datar, Naik, and Radcliffe (1998)
used the turnover rate (number of shares
64 Morningstar Advisor April/May 2013
traded as a fraction of the number of shares
outstanding) as a proxy for liquidity and
found that firm-level stock returns are strongly
negatively related to their turnover rates.
Using autocorrelation in returns as a proxy
for illiquidity, Khandani and Lo (2011) showed
that illiquidity premiums are generally
positive and significant, ranging from 2.74%
to 9.91% per year among hedge funds
and fixed-income mutual funds. These results
all support the notion of an illiquidity premium:
Lower levels of liquidity relate to higher
average returns.
At the macro-level, liquidity has also been
shown to be an important variable in the
pricing of assets. Stock prices relate crosssectionally to fluctuations in aggregate
liquidity [Amihud (2002), Pastor and Stambaugh
(2003), Kamara, Lou, and Sadka (2008)].
This research further shows that common
measures of liquidity risk move together
and that liquidity influences the market return,
not just the return of a single asset,
cross-sectionally.
Table of Contents for the Digital Edition of Morningstar Advisor - April/May 2013
Morningstar Advisor - April/May 2013
Contents
Contributors
Letter From the Editor
The Pursuit of Happiness and Financial Advice
What Strategies Do You Use to Control Risk?
Driven to Succeed for Clients and Family
How to Assess a Portfolio’s Bond Risk
Luck, Skill, and Investing
Investments á la Carte
Investment Briefs
Investing’s No- Brainers Have Costs
A Defensive Ride
Risk On/On Risk
The Risk of Being Overconfident
Year of Living Dangerously
The Risk-Parity Approach
A Guide to Mutual Funds Running Risk-Parity Strategies
What Moats Tell Us About Risk
Risk’s Wake-Up Call
Seeing Is Believing
Why Investors Lag the Returns of Their Funds
Liquidity Signals
Pump Them Up
Golden Oldies Keep on Truckin’
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
Our Social Blind Spot
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