Long-term reversal and value effects: the role of liquidity risk

Shunwei Zhu, Hailong Liu and Thomas Boryniec

Applied Economics, 2023, vol. 55, issue 14, 1546-1566

Abstract: This paper demonstrates that liquidity risk helps explain the return patterns of stocks with high book-to-market ratios and low intangible returns. We document empirical evidence that (1) liquidity shocks, the unexpected variation in liquidity factors that are orthogonal to the firm’s past accounting performance, predict stock returns, (2) stocks with higher book-to-market ratios or lower intangible returns have higher exposure to aggregate capital constraint measures (i.e. these stocks possess higher liquidity risk) and (3) the returns of long-term contrarian strategies based on liquidity shocks, book-to-market ratios and intangible returns are highly correlated and serve as proxies for returns from liquidity provision. Moreover, liquidity-providing returns are stronger in declining markets as well as when the market volatility is high, indicating that liquidity providers are capital-constrained in providing liquidity under such conditions.

Date: 2023
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DOI: 10.1080/00036846.2022.2097634

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