Momentum & Liquidity : Do Liquidity Strategies Add Return?

Sammanfattning: Momentum can be explained as a passive strategy which is rebalanced continually over time. It can be divided into a long position in observed “winners”, and a short position in observed “losers”. This study tries to find out if some kind of liquidity strategy can increase any abnormal return generated by a conventional momentum strategy. Our data is based on monthly returns from all listed companies at Stockholm Stock Exchange between January 1997 and June 2005. We have, in addition to a plain momentum strategy, composed four different liquidity strategies, based on four different observing periods and four different holding periods. Our findings show that momentum has been present during our observation period, where the most profitable portfolio has an observation period of 3 months and a holding period of 6 months, and generates an abnormal return of 253 percent. Or findings from adding liquidity as a second component show that the most profitable strategy is to reverse the high-low strategy with observe and hold periods of 12 months, which has generated an abnormal return of 345% and a risk-adjusted alpha of 0.411. We can also conclude that additional abnormal and risk-adjusted return has been generated by adding liquidity as a second component to plain momentum. Overall the prevailing strategy regarding liquidity is to go long in low volume loser or short in high volume losers. We also find that the most extreme values are generated in the 12 month holding period portfolios. Reasonable explanations for these findings might be derived from a potential steeper upside in low liquidity losers, company specific characteristics and behavioural theories, but can not be concluded beyond reasonable doubt out of the results in this paper.