Predicting Equity Liquidity

Abstract

In this paper we develop a measure of liquidity, price impact, which quantifies the change in a firm's stock price associated with its observed net trading volume. For a large set of institutional trades we compare out-of-sample, characteristic-based estimates of price impact to actual price impacts. Predictive predetermined firm characteristics, chosen to proxy for the severity of adverse selection in the equity market, the non-information-based costs of making a market in the stock, and the extent of shareholder heterogeneity, include relative size, historical relative trading volume, institutional holdings, and the inverse of the stock price. We find numerous aspects of trade execution which are significantly related to the price impact forecast error in economically plausible ways: For example, the predicted price impact overestimates the actual price impact for very large trades, for trades executed in a more patient manner, and for trades where the institution pays higher commissions.Liquidity, Price Impact, Transactions Costs

Relative valuation and analyst target price forecasts

“…The reverse is true for Portfolio 9, in which the majority of the stocks suffer recent downgrades (percentage upgrades and downgrades are 19.7% and 56.7%, respectively). Panel B also reports various liquidity-related portfolio characteristics, which include the price impact of Breen, Hodrick, and Korajczyk (2002) (Pimpact), the percentage bid-ask spread (Pspread), and the Amihud measure of Amihud (2002). 5 Table 3 shows that the first post-formation month excess returns (in excess of the risk-free rate) in general are increasing in TPER.…”

“…We estimate the average percentage spread to be 20.2 bp (Portfolio 1) and 15.2 bp (Portfolio 9). Our estimates of the average price impact [Pimpact calculated as in Breen, Hodrick, and Korajczyk (2002) and assuming $1million traded per hour] are 18.3 bp for Portfolio 1 and 14.6 bp for Portfolio 9, respectively. The magnitudes of the price impacts are smaller than those documented in Keim and Madhavan (1996) since we are only considering S&P 500 stocks and since liquidity has improved substantially over time.…”

“…TheAmihud (2002) measure, calculated as the ratio between the absolute return on a stock and the dollar trading volume (both daily) isAmihud ¼ jdaily returnj=ðdaily $ volumeÞ:Breen, Hodrick, and Korajczyk (2002) propose a direct measure of price impact using high frequency tick-by-tick data. Each trade is categorized as either buyer or seller initiated using the Lee and Ready (1991) methodology (i.e., depending on whether the transaction price is closer to the bid or ask and in case of tied comparing to the last observed trade).…”

The impact of illiquidity on the asset management of insurance companies

“…Following Pereira and Zhang (2004), we consider a permanent price impact function similar to He and Mamaysky (2001) and Breen et al (2002). Abstracting from any other influences, the price change caused by trading is given by…”

“…They find a price impact of about 1 percent. Breen et al (2002) examine NYSE and AMEX-listed stocks from 1993 to 1997. They determined that an increase of net turnover during a five-minute interval by 0.1% of the shares outstanding produces an average price impact of 2.65%.…”