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Department of Economics, Lund University Working Papers, Department of Economics, Lund University

No 2009:7:
Dynamics in Systematic Liquidity

Björn Hagströmer (), Richard G. Anderson (), Jane Binner () and Birger Nilsson ()

Abstract: We develop the principal component analysis (PCA) approach to systematic liquidity measurement by introducing moving and expanding estimation windows. We evaluatethese methods along with traditional estimation techniques (full sample PCA and market average) in terms of ability to explain (1) cross-sectional stock liquidity and (2) cross-sectional stock returns. For several traditional liquidity measures our results suggest an expanding window specification for systematic liquidity estimation. However, for price impact liquidity measures we find support for a moving window specification. The market average proxy of systematic liquidity produces the same degree of commonality, but does not have the same ability to explain stock returns as the PCA-based estimates.

Keywords: systematic liquidity; market liquidity; commonality; dynamic principal component analysis; robust PCA; (follow links to similar papers)

JEL-Codes: G11; G12; (follow links to similar papers)

34 pages, May 25, 2009

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