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Expected Returns and Liquidity Premium on the Paris Bourse: an Empirical Investigation

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... (4) Biais, Hillion t Spatt (1995) montrent empiriquement que fonctions de prix observées sur les cinq meilleures limites ne s'écarte que faiblement de la linéarité. (5) Les capitaux, les volumes échangés ou encore le débit sont parfois considérés comme des mesures de liquidité [voir Hamon et Jacquillat (1997)]. (6) Les résultats obtenus ne dépendent pas du modèle retenu. ...
... We show there is a positive link between the required rate of return and the relative spread, but the link is more significant between the required rate of return and free float. The results of the present paper were obtained using about three times as much data (see Hamon and Jacquillat (1997)).Figure 1 andTable 1 document the size effect in France over a twelve year period. 6 On the first trading day of each month, three portfolios containing an equal number of stocks are formed based on their free float: low, medium, and high. ...
Article
Size has become a significant factor in explaining returns. According to the size effect, smaller capitalization stocks on average outperform larger capitalization stocks over long periods of time. This paper first documents the traditional size effect on the French market for the 1986–1998 period. It introduces a new proxy for size, free float, which is argued to be the appropriate measure of size and liquidity for most non-US markets. Evidence is presented of a negative link between historical returns and free float. The link is significant even outside of the month of January, a notable divergence from results obtained on the NYSE. The rest of the paper is an attempt to take advantage of this ‘ex-post’ phenomenon on an ‘ex-ante’ basis, with an empirical study of the link between expected return, risk, and liquidity in a sample consisting of the main 150 stocks quoted on the Paris Bourse between January 1986 and January 1998. Liquidity premiums are estimated for portfolios from both a univariate and a multivariate perspective. The paper shows how risk and liquidity premiums can be used separately or in tandem for market timing and asset allocation. In all cases, the use of both premiums together leads to superior performance. Results confirm our measurements of liquidity and liquidity premiums and supply evidence that liquidity premiums together with risk premiums are useful in active asset management.
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Liquidity is typically defined as the ability to convert an asset into an amount of cash equal to its current market value. Liquidity became a major stake for stock exchange authorities as shown by the numerous current reorganisation projects. This work contributes to the existing literature on several dimensions. First, we examine the concept of liquidity. Asset liquidity or still market liquidity are the result of many efforts. We show that determinants of the liquidity of a market are numerous. Nevertheless it isn’t easy to analyse the incidence of these various factors because liquidity is conceptually simple yet difficult to quantitatively measure. Indeed, the numerous propositions of liquidity measures, which we present, provide sometimes contradictory results. In front of these uncertainties in the perception of the liquidity level, the econometrics of ultra high-frequency data is able to bring elements to help us to understand the underlying mechanism. We propose, in this way, a dynamic measure of market liquidity that directly indicates the depth of the Paris Stock Exchange, with price duration models. Liquidity risk is financial risk from a possible loss of liquidity. We argue that liquidity is an important part of overall risk and is therefore an important component to model. So, we propose a new measure of liquidity risk, which is constructed from the return during a market event defined by a volume movement. Our results indicate that we can distinguish a systematic liquidity risk, which refers to liquidity fluctuation driven by factors beyond individual investors’ control, from an endogenous liquidity risk, which refers to liquidity fluctuations driven by individual actions such as the investors’ position. These results have consequences on the hedging strategies but also on the orders management. By means of a new tool, the Order Book Reconstruction, we undertake by the analysis of the order flow. We show the existence of a hidden liquidity on the Paris Stock Exchange and the presence of orders’ management strategies. Our analysis also demonstrates the existence of a liquidity dynamics.
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This paper studies the effect of the bid-ask spread on asset pricing. We analyze a model in which investors with different expected holding periods trade assets with different relative spreads. The resulting testable hypothesis is that market-observed expexted return is an increasing and concave function of the spread. We test this hypothesis, and the empirical results are consistent with the predictions of the model.
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All trades executed by 37 large investment management firms from July 1986 to December 1988 are used to study the price impact and execution cost of the entire sequence (“package”) of trades that we interpret as an order. We find that market impact and trading cost are related to firm capitalization, relative package size, and, most importantly, to the identity of the management firm behind the trade. Money managers with high demands for immediacy tend to be associated with larger market impact.
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This paper empirically investigates the seasonal behavior of the liquidity premium in asset pricing. The evidence suggests a strong seasonal component. In the 1961–1990 period, the liquidity premium is reliably positive only during the month of January. For the non-January months, one cannot detect a positive liquidity premium. The impact of the relative bid-ask spreads on asset pricing in non-January months cannot be reliably distinguished from zero. In contrast to Amihud and Mendelson (1986), however, our evidence suggests that the size effect is significant, even after controlling for spreads.
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This paper shows that the stock price incorporates performance information that cannot be extracted from the firm's current or future profit data. The additional information is useful for structuring managerial incentives. The amount of information contained in the stock price depends on the liquidity of the market. Concentrated ownership, by reducing market liquidity, reduces the benefits of market monitoring. Integration is associated with weakened managerial incentives and less market monitoring. The paper also studies the equilibrium size of the stock market as a function of investor preferences and the available amounts of long- and short-term capital. Copyright 1993 by University of Chicago Press.
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A dynamic model of insider trading with sequential auctions, structured to resemble a sequential equilibrium, is used to examine the informational content of prices, the liquidity characteristics of a speculative market, and the value of private information to an insider. The model has three kinds of traders: a single risk neutral insider, random noise traders, and competitive risk neutral market makers. The insider makes positive profits by exploiting his monopoly power optimally in a dynamic context, where noise trading provides camouflage which conceals his trading from market makers. As the time interval between auctions goes to zero, a limiting model of continuous trading is obtained. In this equilibrium, prices follow Brownian motion, the depth of the market is constant over time, and all private information is incorporated into prices by the end of trading.
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Treynor J. L., 1978, "Liquidity, Interest Rates, and Inflation," unpublished manuscript. Contents 1. INTRODUCTION...................................................................................................................................... 3