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Time-Varying Liquidity and Momentum Profits

Published online by Cambridge University Press:  29 December 2016

Doron Avramov ,
Si Cheng  and
Allaudeen Hameed
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Abstract

A basic intuition is that arbitrage is easier when markets are most liquid. Surprisingly, we find that momentum profits are markedly larger in liquid market states. This finding is not explained by variation in liquidity risk, time-varying exposure to risk factors, or changes in macroeconomic condition, cross-sectional return dispersion, and investor sentiment. The predictive performance of aggregate market illiquidity for momentum profits uniformly exceeds that of market return and market volatility states. While momentum strategies have been unconditionally unprofitable in the United States, in Japan, and in the Eurozone countries in the last decade, they are substantial following liquid market states.

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Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 51 , Issue 6 , December 2016 , pp. 1897 - 1923
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2016 

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