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Dynamics in systematic liquidity

  • Björn Hagströmer
  • Richard G. Anderson
  • Jane M. Binner
  • Birger Nilsson

We develop the principal component analysis (PCA) approach to systematic liquidity measurement by introducing moving and expanding estimation windows. We evaluate these 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.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2009-025.

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Date of creation: 2009
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Handle: RePEc:fip:fedlwp:2009-025
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