The strategy uses Amihud’s illiquidity measure to sort U.S. stocks into deciles by idiosyncratic liquidity, employing a value-weighted, monthly rebalanced approach, long high-liquidity and short low-liquidity stocks.
ASSET CLASS: stocks | REGION: United States | FREQUENCY:
Monthly | MARKET: equities | KEYWORD: Idiosyncratic, Liquidity
I. STRATEGY IN A NUTSHELL
The strategy forms long–short portfolios based on firm-specific liquidity, buying high-liquidity stocks and shorting low-liquidity ones using Amihud’s illiquidity measure.
II. ECONOMIC RATIONALE
Idiosyncratic liquidity predicts future returns as it reflects firm-specific trading efficiency and investor behavior, offering excess profits beyond systematic liquidity effects.
III. SOURCE PAPER
Systematic vs. Idiosyncratic Liquidity: Cross-section of Stock Returns [Click to Open PDF]
Baris Ince, Department of Economics, University of Essex
<Abstract>
This paper decomposes firm-specific monthly-varying illiquidity into three components: (i) alpha, (ii) systematic, (iii) idiosyncratic. Investors demand a premium to hold stocks with high systematic illiquidity. However, systematic illiquidity premium disappears when very small stocks are excluded. On the other hand, investors tend to underreact to idiosyncratic (il)liquidity. Hence, stocks with high (low) idiosyncratic liquidity generate positive (negative) future risk-adjusted returns. More specifically, stocks in the highest idiosyncratic liquidity quintile generate 7% more annualized risk-adjusted return compared to stocks in the lowest idiosyncratic liquidity quintile.
IV. BACKTEST PERFORMANCE
| Annualised Return | 11.09% |
| Volatility | 11.3% |
| Beta | 0.061 |
| Sharpe Ratio | 0.98 |
| Sortino Ratio | -0.075 |
| Maximum Drawdown | N/A |
| Win Rate | 50% |
