Liquidity premium and the Corwin-Schultz bid-ask spread estimate
Abstract
Purpose
The purpose of this paper is to explore the price implication of a newly developed estimator of the bid-ask spread by Corwin and Schultz (2012). The paper focusses on whether the new measure as a liquidity proxy commands a significant premium. The research helps the understanding on the validity of the Corwin-Schultz estimate as a liquidity measure.
Design/methodology/approach
The authors carry out their examination based on the portfolio approach, cross-sectional regressions, and time-series regressions. For comparison, the authors also adopt other three liquidity proxies and mainly rely on the Fama-French three-factor model as the benchmark. The sample includes NYSE/AMEX/ARCA/NASDAQ ordinary common stocks over 1926-2010.
Findings
The paper finds that Corwin-Schultz spread lacks significant power to predict returns either in the pre- or post-1963 period. In contrast, other liquidity measures such as the price impact of Amihud (2002), trading discontinuity of Liu (2006), and turnover show stronger return predictability than the Corwin-Schultz spread estimate.
Research limitations/implications
The evidence indicates the limited ability of the Corwin-Schultz spread estimate to describe liquidity.
Practical implications
The comparison of the Corwin-Schultz spread with other liquidity measures helps practitioners and academic researchers to identify the appropriate proxy.
Originality/value
This paper, for the first time, provides a thorough assessment of the Corwin-Schultz spread estimate as a liquidity proxy, which distinguish from Corwin and Schultz (2012) who focus on whether their spread estimate measures transaction costs. Our study not only helps practitioners and academic researchers to select an adequate liquidity measure and an asset pricing model to use, but it also sheds light on the current debate about whether transaction costs have the first order importance in asset pricing.
Keywords
Acknowledgements
JEL Classification — G12
The authors are grateful for valuable comments from the anonymous reviewers whose suggestions were useful in putting the paper in its present form. Our special gratitude goes to Chaoshin Chiao from National Dong Hwa University, the discussant at the 2013 CFRI Conference, and Wednesday seminar participants at Shanxi University. The authors thank their native English friend Sallie H. Wilson from Dartmouth, MA, USA, for her careful proofreading of the paper. However, the authors are responsible for any remaining errors.
The paper also got foundation from the following three projects: National Natural Science Foundation of China (No. 71371113); Humanity & Social Science Foundation by the Ministry of Education of China (No. 13YJA790154); Research Project supported by Shanxi Scholarship Council of China (No. 2012023).
Citation
Zhang, X., Yang, J., Su, H. and Zhang, S. (2014), "Liquidity premium and the Corwin-Schultz bid-ask spread estimate", China Finance Review International, Vol. 4 No. 2, pp. 168-186. https://doi.org/10.1108/CFRI-09-2013-0121
Publisher
:Emerald Group Publishing Limited
Copyright © 2014, Emerald Group Publishing Limited