Mutual Fund’s R^2 as Predictor of Performance

We propose that fund performance is predicted by its R^2, obtained by regressing its return on the Fama-French-Carhart four benchmark portfolios. Lower R2, or higher idiosyncratic risk relative to total risk, measures selectivity or active management. We show that lagged R2 has significant negative predictive coefficient in predicting alpha or Information Ratio. This is consistent with Cremers and Petajisto’s (2008) results on the effect of selectivity. Funds ranked into lagged lowest-quintile R2 and highest-quintile alpha produce significant alpha of 2.8%. Also, both fund RMSE and return volatility predict the following year’s performance with significant positive and negative coefficients, respectively. Across funds, R^2 is an increasing function of fund size and a decreasing function of its age, its manager tenure and its past performance, but better performance induces funds to subsequently increase their R^2

Flight to Liquidity and Global Equity Returns

Investment practice and academic literature suggest a great degree of interaction between the world’s stock markets and most liquid and safe assets, such as U.S. Treasuries. Using data from 46 markets and a 30-year time period, we examine the impact of “flight-to-liquidity” events on global asset valuation. This wide cross-sectional and time-series sample provides a natural setting for analyzing the link between changes in the illiquidity of Treasuries and expected equity returns. Our illiquidity measure is the average percentage bid-ask spread of off-the-run U.S. Treasury bills with maturities of up to one year. We find that this proxy predicts stock market illiquidity and future equity returns in both developed and emerging markets. This predictive relation remains intact after controlling for various world and country-level variables. Asset pricing tests further reveal that Treasury bond illiquidity is a significantly priced factor even in the presence of other conventional risks, such as those of the world stock market, foreign exchange, local equity market variance and illiquidity, as well as the term spread. Our results indicate that flight-to-liquidity risk is an important determinant of returns in global equity markets

Mutual Fund’s R^2 as Predictor of Performance

We propose that fund performance is predicted by its R^2, obtained by regressing its return on the Fama-French-Carhart four benchmark portfolios. Lower R2, or higher idiosyncratic risk relative to total risk, measures selectivity or active management. We show that lagged R2 has significant negative predictive coefficient in predicting alpha or Information Ratio. This is consistent with Cremers and Petajisto’s (2008) results on the effect of selectivity. Funds ranked into lagged lowest-quintile R2 and highest-quintile alpha produce significant alpha of 2.8%. Also, both fund RMSE and return volatility predict the following year’s performance with significant positive and negative coefficients, respectively. Across funds, R^2 is an increasing function of fund size and a decreasing function of its age, its manager tenure and its past performance, but better performance induces funds to subsequently increase their R^2

Flight to Liquidity and Global Equity Returns

Investment practice and academic literature suggest a great degree of interaction between the world’s stock markets and most liquid and safe assets, such as U.S. Treasuries. Using data from 46 markets and a 30-year time period, we examine the impact of “flight-to-liquidity” events on global asset valuation. This wide cross-sectional and time-series sample provides a natural setting for analyzing the link between changes in the illiquidity of Treasuries and expected equity returns. Our illiquidity measure is the average percentage bid-ask spread of off-the-run U.S. Treasury bills with maturities of up to one year. We find that this proxy predicts stock market illiquidity and future equity returns in both developed and emerging markets. This predictive relation remains intact after controlling for various world and country-level variables. Asset pricing tests further reveal that Treasury bond illiquidity is a significantly priced factor even in the presence of other conventional risks, such as those of the world stock market, foreign exchange, local equity market variance and illiquidity, as well as the term spread. Our results indicate that flight-to-liquidity risk is an important determinant of returns in global equity markets

Intraday Patterns in the Cross-section of Stock Returns

Motivated by the literature on investment flows and optimal trading, we examine intraday predictability in the cross-section of stock returns. We find a striking pattern of return continuation at half-hour intervals that are exact multiples of a trading day, and this effect lasts for at least 40 trading days. Volume, order imbalance, volatility, and bid-ask spreads exhibit similar patterns, but do not explain the return patterns. We also show that short-term return reversal is driven by temporary liquidity imbalances lasting less than an hour and bid-ask bounce. Timing trades can reduce execution costs by the equivalent of the effective spread

The impact of firm size and liquidity on the cost of external finance in Africa

Established illiquidity measures are constructed for emerging markets in Africa and used to determine which best explains trading costs. Costs of equity are derived from an augmented Capital Asset Pricing Model for a sample of emerging financial markets generally ignored in the literature. These include: South Africa and Namibia, three countries in North Africa and four in Sub-Saharan Africa (SSA), plus London and Paris as examples of integrated markets. Minimum variance portfolios are constructed and asset weights derived, with the sample divided into countries dependent on their legal regime. Portfolio weights are shown to be directly related to well-regulated markets with high standards of corporate governance and disclosure, and firms seeking cost-effective finance from SSA stock markets are at a distinct disadvantage compared with those in Northern Africa, South Africa and, in particular, London and Paris

A comparison of the efficacy of liquidity, momentum, size and book-to-market value factors in equity pricing on a heterogeneous sample: evidence from Asia

This paper compares the size and book-to-market value factors of Fama and French (1993) alongside Momentum of Jagadeesh and Titman (1993) with two Liu (2006) liquidity factors formed from 1 year rebalancing and 1 month rebalancing respectively. A heterogeneous and comprehensive sample of the top blue chip stocks of all national Asian equity markets with further differentiation undertaken between sub samples formed for Japan only and Asia excluding Japan for period January 2000 to August 2014. Our empirical results suggest that multifactor time invariant pricing models based on augmented capital asset pricing model (CAPM) framework are ineffective in explaining the cross section of stock returns in the presence of significant inter and intra-market segmentation. However an alternative model specification based on a time varying parameter specification and using same sets of factors yields significant enhancements in explaining cross section of stock returns across universe. We find that momentum factor largely lacks significance while a time varying two factor model, based on CAPM plus liquidity factor, is optimal. The liquidity factor being that of Liu (2006) and annually rebalanced. Our findings are important for investment managers seeking appropriate factors and modelling techniques to hedge against risks as well as firm’s financial managers seeking to reduce costs of equity capital

Price-signaling and return-chasing: international evidence from maturing REIT markets

This paper examines the liquidity of international real estate securities across ten markets over the period 1990-2015. We apply and compare results for four different measures of liquidity, and find that while liquidity has increased consistently, wide variations still exist across markets, with the U.S. and Japan in the lead. Our results also suggest that the introduction of local REIT regimes did not have any pervasive effects on stock liquidity. When we study the relationship between liquidity and returns, we document new and consistent evidence for international return-chasing behavior, whose pattern is a function of local market efficiency, listed real estate market maturity, and stock ownership dispersion. The introduction of REIT regimes seems to weaken the importance of extra performance over and above general equity returns as investors tend to allocate funds to real estate securities within real estate rather than equity portfolios

Stock liquidity and SMEs’ likelihood of bankruptcy:evidence from the US market

We study the association between the stock liquidity of SMEs in the US and their likelihood of bankruptcy, using a dataset that comprises information on 5075 firms over the time period from 1984 to 2013 using the hazard model of Campbell et al. (2008). We find that less liquid stocks are associated with higher probability of bankruptcy, although there is substantial heterogeneity across industries regarding the predictive power of the liquidity measure on the likelihood of bankruptcy. Furthermore, the exchange where the SMEs are listed also affects the likelihood of bankruptcy. Classification performance tests conclude that adding a liquidity measure variable to the Campbell et al. (2008) model improves its predictive power