Skip to main content
SpringerLink
Log in

Run lengths and liquidity

  • Published:
Annals of Operations Research Aims and scope Submit manuscript

Abstract

We develop a market-wide illiquidity risk factor based on run lengths and find that it is priced using standard asset-pricing specifications. Our theoretical framework of equity returns derives the result that average run lengths of individual stocks proxy for illiquidity, and are related to common measures of liquidity such as trading volume and trade price-impact. This relationship holds irrespective of the sampling frequency in the computation of run lengths. Thus, liquidity can be quantified by examining a stock’s run length signature, providing a statistical mechanics link across illiquidity metrics. Tests using daily equity return data for all stocks over the period 1962–2005 find that run lengths are decreasing in turnover, and increasing with bid-ask spreads, and price-impact. Illiquidity is shown to be a risk factor/characteristic in explaining equity returns.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

References

  • Acharya, V., & Pedersen, L. (2005). Asset pricing with liquidity risk. Journal of Financial Economics, 77(2), 375–410.

    Article  Google Scholar 

  • Amihud, Y. (2002). Illiquidity and stock returns: cross-section and time-series effects. Journal of Financial Markets, 5, 31–56.

    Article  Google Scholar 

  • Amihud, Y., & Mendelson, H. (1986). Asset pricing and the bid-ask spread. Journal of Financial Economics, 17, 223–249.

    Article  Google Scholar 

  • Amihud, Y., Mendelson, H., & Pedersen, L. (2005). Liquidity and asset prices. Foundations and Trends in Asset Prices, 1(4), 269–364.

    Article  Google Scholar 

  • Avramov, D., & Chordia, T. (2001). Characteristic scaled betas. Working paper, Emory University.

  • Avramov, D., Chordia, T., & Goyal, A. (2006). Liquidity and autocorrelations in individual stock returns. Journal of Finance, 61(5), 2365–2394.

    Article  Google Scholar 

  • Berk, J. (2000). Sorting out sorts. Journal of Finance, 55, 407–427.

    Article  Google Scholar 

  • Bonanno, G., Lillo, F., & Mantegna, R. (2000). Dynamics of the number of trades of financial securities. Physica A, 280, 136–141.

    Article  Google Scholar 

  • Brennan, M., & Subrahmanyam, A. (1996). Market microstructure and asset pricing: on the compensation for illiquidity in stock returns. Journal of Financial Economics, 41, 441–464.

    Article  Google Scholar 

  • Campbell, J., Grossman, S., & Wang, J. (1993). Trading volume and serial correlation in stock returns. Quarterly Journal of Economics, 108, 905–939.

    Article  Google Scholar 

  • Carhart, M. (1997). On persistence in mutual fund performance. Journal of Finance, 52(1), 57–82.

    Article  Google Scholar 

  • Cetin, U., Jarrow, R., Protter, P., & Warachka, M. (2006). Pricing options in a black-scholes economy with illiquidity: theory and empirical evidence. Review of Financial Studies, 19(2), 493–529.

    Article  Google Scholar 

  • Chacko, G. (2004). Liquidity risk in the corporate bond markets. Working paper, Harvard Business School.

  • Chacko, G., Jurek, J., & Stafford, E. (2008a). The price of immediacy. Journal of Finance, 63(3), 1253–1290.

    Article  Google Scholar 

  • Chacko, G., Mahanti, S., Mallik, G., & Subrahmanyam, M. (2008b). The determinants of liquidity in the corporate bond markets: an application of latent liquidity. Journal of Financial Economics, 88(2), 272–298.

    Article  Google Scholar 

  • Chordia, T., Roll, R., & Subrahmanyam, A. (2005). Liquidity and market efficiency. Working paper, Emory University.

  • Chordia, T., Goyal, A., Sadka, G., Sadka, R., & Shivakumar, L. (2006). Liquidity and the post-earnings-announcement-drift. Working paper, Emory University.

  • Conrad, J., Hameed, A., & Niden, C. (1994). Volume and autocovariances in short-horizon individual stock returns. Journal of Finance, 49(4), 1305–1329.

    Article  Google Scholar 

  • Daniel, K., & Titman, S. (1997). Evidence on the characteristics of cross-sectional variation in stock returns. Journal of Finance 52(1), 1–33.

    Article  Google Scholar 

  • Das, S., & Hanouna, P. (2007). Hedging credit: equity liquidity matters. Journal of Financial Intermediation, 18(1), 112–123.

    Article  Google Scholar 

  • de Jong, F., & Driessen, J. (2005). Liquidity risk premia in corporate bond markets. Working paper, University of Amsterdam.

  • Easley, D., Kiefer, N., O’Hara, M., & Paperman, J. (1996). Liquidity, information, and infrequently traded stocks. Journal of Finance, 51, 1405–1436.

    Article  Google Scholar 

  • Easley, D., Kiefer, N., & O’Hara, M. (1997). One day in the life of a very common stock. The Review of Financial Studies, 10(3), 805–835.

    Article  Google Scholar 

  • Edgington, E. S. (1961). Probability table for number of runs of signs of first differences in ordered series. Journal of the American Statistical Society, 56, 156–159.

    Google Scholar 

  • Fama, E. F. (1965). The behavior of stock market prices. Journal of Business, 38(1), 34–105.

    Article  Google Scholar 

  • Fama, E. F., & French, K. R. (1992). The cross-section of expected stock returns. Journal of Finance, 47, 427–465.

    Article  Google Scholar 

  • Fama, E. F., & French, K. R. (1993). Common risk factors in the returns on stocks and bonds. Journal of Financial Economics, 33, 3–56.

    Article  Google Scholar 

  • Fama, E. F., & MacBeth, J. D. (1973). Risk, return, and equilibrium: empirical tests. Journal of Political Economy, 81, 607–636.

    Article  Google Scholar 

  • Getmansky, M., Lo, A., & Makarov, I. (2004). An econometric model of serial correlation and illiquidity in hedge fund returns. Journal of Financial Economics, 74(3), 529–610.

    Article  Google Scholar 

  • Glosten, L. R. (1989). Insider trading, liquidity, and the role of the monopolist specialist. Journal of Business, 62(2), 211–235.

    Article  Google Scholar 

  • Grafton, R. G. T. (1981). The runs-up and runs-down tests. Applied Statistics, 30(1), 81–85.

    Article  Google Scholar 

  • Grossman, S., & Miller, M. (1988). Liquidity and market structure. Journal of Finance, 43, 617–633.

    Article  Google Scholar 

  • Hasbrouck, J. (1991). Measuring the information content of stock trades. Journal of Finance, 46, 179–207.

    Article  Google Scholar 

  • Hasbrouck, J. (2006). Trading costs and returns for US equities: estimating effective costs from daily data. Working paper, New York University.

  • Hendershott, T., & Seasholes, M. (2007). Market maker inventories and stock prices. American Economic Review Papers and Proceedings, 97(2), 210–214.

    Google Scholar 

  • Heston, S., & Sadka, R. (2005). Seasonal liquidity and stock returns. Working paper, University of Washington, Seattle.

  • Jegadeesh, N., & Titman, S. (1993). Returns to buying winners and selling losers: Implications for stock market efficiency. Journal of Finance, 48, 65–91.

    Article  Google Scholar 

  • Jones, C., Kaul, G., & Lipson, M. (1994). Transactions, volume and volatility. Review of Financial Studies, 7, 631–651.

    Article  Google Scholar 

  • Karpoff, J. (1987). The relation between price change and trading volume: a survey. Journal of Financial and Quantitative Analysis, 22, 109–126.

    Article  Google Scholar 

  • Korajczyk, R., & Sadka, R. (2008). Pricing the commonality across alternative measures of liquidity. Journal of Financial Economics, 87, 45–72.

    Google Scholar 

  • Lesmond, D., Ogden, J., & Trzcinka, C. (1999). A new estimate of transaction costs. Review of Financial Studies, 12(5), 1113–1141.

    Article  Google Scholar 

  • Li, J., Morradian, R., & Zhang, W. (2007). Is illiquidity a risk factor? A critical look at commission costs. Financial Analysts Journal, 63(4), 28–39.

    Article  Google Scholar 

  • Lillo, F., & Doyne Farmer, J. (2005). The key role of liquidity fluctuations in determining large price fluctuations. Fluctuations and Noise Letters, 5, 209–216.

    Article  Google Scholar 

  • Liu, W. (2003). Liquidity premium and a two-factor model. Working paper, Manchester Business School.

  • McQueen, G., & Thorley, S. (1994). Bubbles, stock returns and duration dependence. Journal of Financial and Quantitative Analysis, 29(3), 379–401.

    Article  Google Scholar 

  • Moore, P. G. (1978). Nonparametric statistics: runs. In W. J. Kruskal & J. Tanur (Eds.), International encyclopedia of statistics (pp. 655–651). New York: Free Press.

    Google Scholar 

  • Newey, W., & West, K. (1987). A simple, positive semi-definite, heteroskedasticity and autocorrelation consistent covariance matrix. Econometrica, 55, 703–708.

    Article  Google Scholar 

  • Pagano, M. (1989). Trading volume and asset liquidity. Quarterly Journal of Economics, 104, 255–274.

    Article  Google Scholar 

  • Pastor, L., & Stambaugh, R. F. (2003). Liquidity risk and expected stock returns. Journal of Political Economy, 111, 642–685.

    Article  Google Scholar 

  • Raghubir, P., & Das, S. (2004). The long and short of it: why are stocks with shorter run-lengths preferred? Working paper, Berkeley, UC.

  • Roll, R. (1984). A simple implicit measure of the effective bid-ask spread in an efficient market. The Journal of Finance, 39(4), 1127–1139.

    Article  Google Scholar 

  • Sadka, R. (2006). Momentum and post-earnings-announcement drift anomalies: the role of liquidity risk. Journal of Financial Economics, 80, 309–349.

    Article  Google Scholar 

  • Shumway, T. (1997). The delisting bias in CRSP data. Journal of Finance, 52, 327–340.

    Article  Google Scholar 

  • Shumway, T., & Warther, V. A. (1999). The delisting bias in CRSPs nasdaq data and its implications for the size effect. Journal of Finance, 54, 2361–2379.

    Article  Google Scholar 

  • von Wyss, R. (2004). Measuring and predicting liquidity in the stock market. Dissertation, University of St. Gallen.

Download references

Author information

Authors and Affiliations

  1. Leavey School of Business, Santa Clara University, 500 El Camino Real, Santa Clara, CA, 95053, USA

    Sanjiv R. Das

  2. Villanova School of Business, Villanova University, 800 Lancaster Avenue, Villanova, PA, 19085, USA

    Paul Hanouna

Authors
  1. Sanjiv R. Das
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Paul Hanouna
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Sanjiv R. Das.

Additional information

Thanks to Viral Acharya, George Chacko, Tarun Chordia, Jennifer Huang, Michael Pagano, George Penacchi, Priya Raghubir, Atulya Sarin, Mark Seasholes, Marti Subrahmanyam and seminar participants at Villanova University, Calpers, QWAFAFEW San Francisco, FDIC, and the University of Chicago conference on liquidity for helpful discussions. We are especially grateful to Yakov Amihud and an unknown referee for numerous suggestions and ideas. The first author acknowledges financial support from the Dean Witter Foundation and a Breetwor Fellowship.

Rights and permissions

Reprints and permissions

About this article

Cite this article

Das, S.R., Hanouna, P. Run lengths and liquidity. Ann Oper Res 176, 127–152 (2010). https://doi.org/10.1007/s10479-008-0508-x

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10479-008-0508-x

Keywords

Search

Navigation