Predicting equity liquidity

William J. Breen*, Laurie Simon Hodrick, Robert A. Korajczyk

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

66 Scopus citations

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.

Original languageEnglish (US)
Pages (from-to)470-483
Number of pages14
JournalManagement Science
Volume48
Issue number4
DOIs
StatePublished - Apr 2002

Keywords

  • Liquidity
  • Price Impact
  • Transactions Costs

ASJC Scopus subject areas

  • Strategy and Management
  • Management Science and Operations Research

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