Liquidity and stock returns: An alternative test

Datar, Vinay; Naik, Narayan Y.; Radcliffe, Robert C.

doi:10.1016/s1386-4181(97)00004-9

Cited by 1,068 publications

(574 citation statements)

References 41 publications

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“…Moreover, the group of firms with the highest implied beta exhibits the highest past stock returns. Third, we observe that implied beta is positively related to stock illiquidity, which is consistent with the findings of Haugen and Baker (1996), Datar, Naik, and Radcliffe (1998), and Chordia, Subrahmanyam, and Anshuman (2001), in that there is a negative correlation between liquidity and expected stock return. Finally, turning to focus on options market-based variables, we note that firms with higher implied betas seem to have greater negative volatility spread, more positive volatility skew, and less negative riskneutral skewness.…”

Section: Resultssupporting

confidence: 89%

Option-Implied Equity Risk and the Cross Section of Stock Returns

Chen

Chung

Tsai

2016

Financial Analysts Journal

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T he classical capital asset pricing model, CAPM (Sharpe 1964;Lintner 1965;Black, Jensen, and Scholes 1972), is the most widely used method in practice for measuring equity risk (e.g., Block 1999; Graham and Harvey 2001;Welch 2008), but several studies have documented its failure to characterize cross-sectional asset prices (e.g., Fama and French 1992, 1993Lewellen and Nagel 2006). Motivated in part by this failure, an abundance of authors have investigated the link between the implied, forwardlooking information in the options market and future stock returns. 1 Recently, Chang, Christoffersen, Jacobs, and Vainberg (2012; hereafter, CCJV) constructed a simple estimate for equity beta from option prices; 2 however, Buss and Vilkov (2012) found a flat relationship between the CCJV beta measure and future stock returns. A potential problem with the approach taken by CCJV is that they made the assumption that idiosyncratic skewness is zero, whereas researchers have found that idiosyncratic skewness affects asset prices (e.g., Boyer, Mitton, and Vorkink 2010; Conrad, Dittmar, and Ghysels 2013).We used forward-looking information from the options market to estimate systematic market risk while controlling for the impact of idiosyncratic skewness. 3 We found that our option-implied beta is a strong predictor of future stock returns and that the associated premium is also a strong predictor of future market returns, providing support for the notion that forward-looking information is embedded in traded equity option prices.More specifically, we used daily option prices to calculate the implied moments of the one-month return distribution for each firm in the sample. Using these option-implied moments, we then estimated the monthly option-implied beta for each firm through nonlinear GMM (generalized method of moments) estimation. We used estimates for 3,484 unique optioned firms over the sample period, January 1996 through December 2012.We found that a long-short portfolio formed on the option-implied beta generated an average monthly risk-adjusted return of 0.96% with a significantly positive t-statistic of 3.47. We further report that the long-short portfolio returns formed on the option-implied beta (e.g., the implied market risk premium) can significantly forecast future market returns with a t-statistic of 3.01. In addition, we found that our option-implied beta is a significant predictor of future realized betas and that the optionimplied market risk premium is positively associated with certain macroeconomic variables, such as the dividend yield and the term spread.We should note that our sample is restricted to firms with equity options outstanding and that our results do not take into account transaction costs or potential short-selling constraints. Firms with options are typically liquid, however, and of large market capitalization.In an attempt to understand why our results differ from those of CCJV (2012), we found that idiosyncratic skewness does correlate with CCJV's implied beta but not with ours, which m...

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Section: Resultssupporting

confidence: 89%

Option-Implied Equity Risk and the Cross Section of Stock Returns

Chen

Chung

Tsai

2016

Financial Analysts Journal

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“…TURN: The logarithm of the firm's share turnover, measured as the trading volume divided by the total number of shares outstanding (Datar, Naik, and Radcliffe, 1998). …”

Section: The Anomaliesmentioning

confidence: 99%

“…11 This gives enough time for investors to set up potential trading strategies. The year of the publications along with the author names are as followssize anomaly (Banz, 1981); book-to-market ratio (Fama and French, 1992); momentum (Jegadeesh and Titman, 1993); reversals (Jegadeesh, 1990); turnover (Datar, Naik and Radcliffe, 1998); accruals (Sloan, 1996); illiquidity (Amihud, 2002); new issues (Pontiff and Woodgate, 2008); idiosyncratic volatility (Ang, Hodrick, Xing, and Zhang, 2006); profitability (Fama and French, 2006); and asset growth (Cooper, Gulen, and Schill, 2008). Since PEAD was first documented in Ball and Brown (1968), prior to the start of our sample period, this anomaly is not used in our pre-and post-discovery analysis.…”

Section: The Impact Of Discoverymentioning

confidence: 99%

Have capital market anomalies attenuated in the recent era of high liquidity and trading activity?

Chordia

Subrahmanyam

Tong

2014

Journal of Accounting and Economics

432

179

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We are grateful to S.P. Kothari (the editor) and two anonymous referees for insightful and constructive feedback. We acknowledge and appreciate financial assistance from the Fink Center for Investment Research at UCLA. We also thank Lieven Baele, Michael AbstractHave Capital Market Anomalies Attenuated in the Recent Era of High Liquidity and Trading Activity?We examine whether the recent regime of increased liquidity and trading activity is associated with attenuation of prominent equity return anomalies due to increased arbitrage.We find that the majority of the anomalies have attenuated, and the average returns from a portfolio strategy based on prominent anomalies have approximately halved after decimalization. We provide evidence that hedge fund assets under management, short interest and aggregate share turnover have led to the decline in anomaly-based trading strategy profits in recent years. Overall, our work indicates that policies to stimulate liquidity and ameliorate trading costs improve capital market efficiency.

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“…Consider an alternate policy that deviates from the candidate optimal policy from time t to time t þ Dt; by investing one unit (to be thought of as a ''small'' amount) in the liquid consol at time t and then converting the resulting liquid consol holding back to the illiquid consol at time t þ Dt: By adopting such a deviation, the agent's consumption increases 12 by 1 À 1Àe 1þe þ OðDtÞ; from the saving of the round-trip transactions costs, if the liquidity shock arrives within ðt; t þ DtÞ: 13 If the liquidity shock arrives at s4t þ Dt; then the agent's consumption decreases by…”

Section: An Agent's Optimal Policymentioning

confidence: 99%

“…2 See, for example, [4,5,8,9,33]. Other related empirical studies on effects of liquidity on asset returns [3,10,11,13,23,29]. 3 See, for example, [2,4,12,21,22,25,[34][35][36].…”

Section: Introductionmentioning

confidence: 99%