Premium
Is there Value‐Added Information in Liquidity and Risk Premiums?
Author(s) -
Hamon Jacques,
Jacquillat Bertrand
Publication year - 1999
Publication title -
european financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.311
H-Index - 64
eISSN - 1468-036X
pISSN - 1354-7798
DOI - 10.1111/1468-036x.00100
Subject(s) - market liquidity , liquidity premium , liquidity risk , economics , accounting liquidity , market capitalization , financial economics , funding liquidity , econometrics , capital asset pricing model , monetary economics , business , stock market , paleontology , horse , biology
Size has become a significant factor in explaining returns. According to the size effect, smaller capitalization stocks on average outperform larger capitalization stocks over long periods of time. This paper first documents the traditional size effect on the French market for the 1986–1998 period. It introduces a new proxy for size, free float, which is argued to be the appropriate measure of size and liquidity for most non‐US markets. Evidence is presented of a negative link between historical returns and free float. The link is significant even outside of the month of January, a notable divergence from results obtained on the NYSE. The rest of the paper is an attempt to take advantage of this ‘ex‐post’ phenomenon on an ‘ex‐ante’ basis, with an empirical study of the link between expected return, risk, and liquidity in a sample consisting of the main 150 stocks quoted on the Paris Bourse between January 1986 and January 1998. Liquidity premiums are estimated for portfolios from both a univariate and a multivariate perspective. The paper shows how risk and liquidity premiums can be used separately or in tandem for market timing and asset allocation. In all cases, the use of both premiums together leads to superior performance. Results confirm our measurements of liquidity and liquidity premiums and supply evidence that liquidity premiums together with risk premiums are useful in active asset management.