Scandinavian Working Papers in Economics

Working Papers,
Lund University, Department of Economics

No 2009:7: Dynamics in Systematic Liquidity

Björn Hagströmer (), Richard G. Anderson (), Jane Binner () and Birger Nilsson ()
Additional contact information
Björn Hagströmer: Aston Business School, Postal: Aston University, Aston Triangle, Birmingham, B4 7ET, England
Richard G. Anderson: Federal Reserve Bank of St. Louis, Postal: Research Division, Federal Reserve Bank of St. Louis, P.O. Box 442, St. Louis, MO 63166-0442 , USA
Jane Binner: Aston Business School, Postal: Aston University, Aston Triangle, Birmingham, B4 7ET, England
Birger Nilsson: Department of Economics, Lund University, Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund, Sweden

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

JEL-codes: G11; G12

34 pages, May 25, 2009

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