Systematic liquidity and excess returns: evidence from the London Stock Exchange

Abstract

Purpose

The purpose of this paper is to test whether the 2007 identification of commonality in liquidity by Galariotis and Giouvris for the UK is robust to different methodological approaches; to find whether commonality is priced; and to identify how changes in trading regimes, hence liquidity provision, affect the relationship between commonality and excess returns.

Design/methodology/approach

The paper builds on the 2001 methodology of Huberman and Halka. In addition it extracts common factors using principal component analysis to test the effect of commonality on excess returns.

Findings

The findings of this paper confirm the presence of a systematic time‐varying component in UK spreads (under a different approach) even after controlling for well‐known spread determining variables.

Originality/value

The paper provides original evidence on the presence and the effect of systematic liquidity on asset pricing in the UK, showing that it is sensitive to the nature of trading regimes. It is concluded that in order‐driven regimes the effect of commonality on asset pricing is reduced, hence policy makers should consider this when deciding on trading systems

Citation

Galariotis, E.C. and Giouvris, E. (2009), "Systematic liquidity and excess returns: evidence from the London Stock Exchange", Review of Accounting and Finance, Vol. 8 No. 3, pp. 279-307. https://doi.org/10.1108/14757700910980868