Liquidity, Volatility, and Equity Trading Costs Across Countries and Over Time

Ian Domowitz, Jack Glen and Ananth Madhavan

No 322, William Davidson Institute Working Papers Series from William Davidson Institute at the University of Michigan

Abstract: Actual investment performance reflects the underlying strategy of the portfolio manager and the execution costs incurred in realizing those objectives. Execution costs, especially in illiquid markets, can dramatically reduce the notional return to an investment strategy. This paper examines the interactions between cost, liquidity, and volatility, and analyzes their determinants using panel-data for 42 countries from September 1996 to December 1998. We document wide variation in trading costs across countries; emerging markets in particular have significantly higher trading costs even after correcting for factors affecting costs such as market capitalization and volatility. We analyze the inter-relationships between turnover, equity trading costs, and volatility, and investigate the impact of these variables on equity returns. In particular, we show that increased volatility, acting through costs, reduces a portfolio's expected return. However, higher volatility reduces turnover also, mitigating the actual impact of higher costs on returns. Further, turnover is inversely related to trading costs, providing a possible explanation for the increase in turnover in recent years. The results demonstrate that the composition of global efficient portfolios can change dramatically when cost and turnover are taken into account.

Keywords: privatization; government priorities; auctions; revenue maximization; probit analysis; selection bias. (search for similar items in EconPapers)
Pages: pages
Date: 2000-03-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (15)

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Journal Article: Liquidity, Volatility and Equity Trading Costs Across Countries and Over Time (2001)
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Persistent link: https://EconPapers.repec.org/RePEc:wdi:papers:2000-322

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