tag:blogger.com,1999:blog-6704573462403312459.post7595980473745671999..comments2024-03-19T07:46:09.811-04:00Comments on Moneyness: Is the value premium a liquidity premium?JP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.comBlogger41125tag:blogger.com,1999:blog-6704573462403312459.post-28302308923978481512014-03-24T06:01:17.487-04:002014-03-24T06:01:17.487-04:00Agree with the comments above regarding the size p...Agree with the comments above regarding the size premium. A compensation for liquidity risk - if there is such a thing, and I believe there is - is more associated with SMB than with HML. Plenty of extremely liquid, cheap (e.g. low market-to-book, low P/E) names. Think AAPL. I'm sure there is plenty of work out there running liquidity against HML, and guessing the correlations are much lower than liquidity against SMB.Dope Threathttps://www.blogger.com/profile/14739105000565392609noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-63732846812678982532014-03-17T22:17:42.390-04:002014-03-17T22:17:42.390-04:00" You will find that the value risk premium r..." You will find that the value risk premium remains..."<br /><br />Hmmm, it sounds like you've crunched the numbers on this? <br /><br />Note: I have no problem admitting that liquidity probably doesn't explain everything, but it might explain some portion of the various premia. I'm not an extremist on this.JP Koninghttps://www.blogger.com/profile/02559687323828006535noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-89538905854759392512014-03-15T15:22:15.585-04:002014-03-15T15:22:15.585-04:00This is entirely contingent on how one defines liq...This is entirely contingent on how one defines liquidity. Small caps are less liquid than large and do provide higher returns. Value stocks are less volatile than growth but offer (or offered) higher returns. Lower volatility can be considered higher liquidity because they hold their value better across a recession where liquidity is at a premium. Liquidity as ease of selling or as maintaining its value. If greater swings in price are liquidity, then liquidity is to be avoided, not to pay a premium for. Growth with its higher volatility offers less liquidity and less return. Lordhttps://www.blogger.com/profile/06747994571555237739noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-5473311350594766232014-03-15T08:42:33.663-04:002014-03-15T08:42:33.663-04:00Presumably you would also argue that the size prem...Presumably you would also argue that the size premium and other risk premiums are also due to provision of liquidity to the market! At least with the size premium I think the argument would be on more solid ground, given the tendency for smaller stocks to have wider bid-ask spreads and lower turnover than large cap stocks. <br /><br />Consider the following thought experiment: an investor decides to buy and sell companies based on their P/B ratio and finds that, on average, she achieves a higher return from those companies purchased at a low P/B ratio. Since all companies are highly illiquid (I.e. they never trade expect at purchase or sale time) the excess return can't be due to liquidity provision.<br /><br />In terms of exchange traded markets, simply undertake a double sort experiment: sort stocks into deciles according to liquidity (whatever your preferred measure is) and then within each of these groups look at the returns experienced by stoxks with low P/B ratios compared to those with high P/B ratios. You will find that the value risk premium remains, and since we have already sorted for liquidity, this risk premium can't be explained by liquidity provision.<br /><br />Others have posited that the risk premium arises from financial distress and it's correlation with overall equity market returns (I.e. that the value premium often generates negative returns at times when investors strongly dislike such returns and so need to be compensated for that "non-beneficial timing of returns"). This argument is akin to saying that tail risk events are priced, and there is some recent research that supports such a theory. Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-2924293331979943582014-03-14T08:34:50.405-04:002014-03-14T08:34:50.405-04:00Glad you liked it.
"...when looking at price...Glad you liked it.<br /><br />"...when looking at prices of stocks?"<br /><br />We can't really do this yet. <br /><br />But you might be able to observe a pure liquidity premium that has been stripped of any risk premium by offering an investor a synthetic asset that entirely replicates a position in, say, MSFT. The only difference would be that the synthetic asset would be entirely illiquid for, say, 1 year. The discount that the market applies to the synthetic MSFT position relative to the outright MSFT position would indicate the dollar value of the 1-year liquidity services they are forgoing by choosing the synthetic asset. The party offering the synthetic asset needs to be as close to a risk-free institution as possible, like a clearinghouse, say the CME, or a depository of some sort like DTCC.<br /><br />Another way to think of it is that a risk-free institution is offering investors the ability to deposit MSFT for a fixed term. Whatever interest rate investors require will be the liquidity premium.JP Koninghttps://www.blogger.com/profile/02559687323828006535noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-75868735964268027822014-03-13T17:35:04.949-04:002014-03-13T17:35:04.949-04:00Yes of course, that's the definition of "...Yes of course, that's the definition of "value." What I mean by "measured" is "observed." Specifically, can it be separated out from any other kind of premium (like risk premium) when looking at prices of stocks? Otherwise, you can call any otherwise unexplained difference in return a "liquidity premium." If not bid/ask spread, how about average volume or the price of shares (this seems to be the explanation which gets thrown out for a stock split for instance)?<br /><br />P.S. That was the first post of yours I ever read. It was good :)<br /><br />Mike Freimuthhttp://realfreeradical.comnoreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-9627685139369791302014-03-13T11:34:33.655-04:002014-03-13T11:34:33.655-04:00So far I don't have a response from Bill: I em...So far I don't have a response from Bill: I emailed him too, and left a msg for him at Nick Rowe's (where he'd left a comment). I'd love to see you address this separate "definition" concept in your MOA post... :DTom Brownhttps://www.blogger.com/profile/17654184190478330946noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-85704077478753619762014-03-13T11:26:44.075-04:002014-03-13T11:26:44.075-04:00Even among growth stocks there are those with high...Even among growth stocks there are those with higher and lower book-to-market values. Imagine the two companies I was talking about were both growth stocks, and the argument holds. The research shows that as you go further down the rung on p/b's, performance improves, it's not simply that the high decile underperforms and the low decile outperforms.John Hawkinsnoreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-80689297432268782552014-03-12T18:48:40.191-04:002014-03-12T18:48:40.191-04:00In my opinion, the best way to measure liquidity i...In my opinion, the best way to measure liquidity is to find out how much people are willing to pay to own it. I have a bunch of posts on this, this one for instance:<br /><br />http://jpkoning.blogspot.ca/2014/01/different-goods-are-differently-liquid.html<br /><br />We don't measure the value of a pear by measuring its sweetness, but by asking people what they'd be willing to pay for it. It should be the same with liquidity.JP Koninghttps://www.blogger.com/profile/02559687323828006535noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-32027533850787545002014-03-11T21:46:59.687-04:002014-03-11T21:46:59.687-04:00I wonder how you would measure the liquidity of a ...I wonder how you would measure the liquidity of a stock? I would think you could use bid/ask spread. If this is the case, one could buy stocks with a high spread and short those with a low spread and this would capture the gains from liquidity preference. <br /><br />This whole line of reasoning raises the question of why some stocks are more liquid than others though. If two stocks were "equal" in other respects, shouldn't doing this cause the bid/ask spreads (and therefore the returns from creating liquidity) to converge? I suspect there may be a risk premium bound up in this somehow (the two things seem often difficult to disentangle to me).<br /><br />For what it's worth, your account of what banks do here is entirely in line with my view.Mike Freimuthhttp://realfreeradical.comnoreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-82777484216087916862014-03-11T21:41:02.841-04:002014-03-11T21:41:02.841-04:00Steve,
There are surely other factors that expla...Steve, <br /><br />There are surely other factors that explain the variance of price to book value (like expected growth for instance) which are neither behavioral nor liquidity related but these should not cause a difference in expected (risk adjusted) return. This difference in return between google and apple (at least in expectations) is likely much smaller and could be explained by liquidity. Though of course those are probably both pretty liquid (and they may have the same expected return).Mike Freimuthhttp://realfreeradical.comnoreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-49426916391894461362014-03-11T19:43:11.437-04:002014-03-11T19:43:11.437-04:00"If the inefficiency were to be gotten rid of..."If the inefficiency were to be gotten rid of by he low p/b method being mindless, it would be reflected in those stocks being priced higher and thus making them not low p/b stocks."<br /><br />Growth stocks *should* have high P/Bs. It would be an anomaly if they didn't. The anomaly is that they are too high.<br />Maxnoreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-57089398626740710282014-03-11T12:33:15.710-04:002014-03-11T12:33:15.710-04:00Imagine 2 companies with the same book value and t...Imagine 2 companies with the same book value and the same intrinsic value. If there is inefficiency in the market, just as a fact of arithmetic the low p/b stock will be the undervalued one rand the high p/b stock will be overly valued, leaving the low p/b one to return more. If the inefficiency were to be gotten rid of by he low p/b method being mindless, it would be reflected in those stocks being priced higher and thus making them not low p/b stocks. The same thing is true for the SMB phenomenon. That's what's interesting about these phenomena, is that they will be better or equal but rarely ever a worse strategy than the market portfolio. If inefficiency is whittled away to 0, that will be the cause of HML or SMB becoming ineffective strategies, not their mindlessnessJohn Hawkinsnoreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-44931453271872586602014-03-11T02:13:02.054-04:002014-03-11T02:13:02.054-04:00"It is important to note that if there is any..."It is important to note that if there is any inefficiency in the market whatsoever it would be captured by the value anomaly - inefficiently underpriced stocks would have lower P/B's than their inefficiently overpriced counterparts."<br /><br />Low P/B is a signal for cheapness that has worked historically, but it isn't cheapness itself. If low P/B investing got to be a mindless fad, then low P/B stocks could become expensive, and high P/B stocks cheap.<br />Maxnoreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-49293312579639451662014-03-11T01:59:56.592-04:002014-03-11T01:59:56.592-04:00Not every stock is in a popular index. Oddly enoug...Not every stock is in a popular index. Oddly enough one of the requirements of index membership for most indexes is a minimum level of liquidity. It may be that the juiciest opportunity will come from buying stocks outside indexes, and selling them when they are added to indexes.<br />Maxnoreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-63225560899645049942014-03-10T22:41:17.346-04:002014-03-10T22:41:17.346-04:00JP, in case you're wondering why the interest,...JP, in case you're wondering why the interest, there's been a thread going on this on themoneyillusion.com. I won't attempt to find the start of it for you, but here's one entry point (to give a little context):<br /><br />http://www.themoneyillusion.com/?p=26304&cpage=3#comment-322686<br /><br />I do like the "Tom Brown multiple" idea, but I'm guessing there's no need for that as Bill or this fellow: Jurg Niehans, have probably already nailed it down, don't you think (hope)?.<br /><br />I kind of joke about this, but I assume no two econ people agree on anything, especially about fundamental ideas like "money" or any other words for that matter. My philosophy has been to learn what each one means when they use various words. If this thread actually results in two or more people being on the same page, I'll be overjoyed!Tom Brownhttps://www.blogger.com/profile/17654184190478330946noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-82626333805518634642014-03-10T21:55:09.303-04:002014-03-10T21:55:09.303-04:00I certainly hope Bill and I agree, since I learnt ...I certainly hope Bill and I agree, since I learnt the terms from him!<br /><br />But you make a good point. The third category on your list doesn't have its own term. I've been folding it into the MOA. Maybe we can call it the "Tom Brown multiple"?JP Koninghttps://www.blogger.com/profile/02559687323828006535noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-64762628406134409692014-03-10T21:49:47.397-04:002014-03-10T21:49:47.397-04:00Great, thanks JP. I've also asked Bill Woolsey...Great, thanks JP. I've also asked Bill Woolsey to clarify where he stands too, but I haven't heard back yet:<br />http://monetaryfreedom-billwoolsey.blogspot.com/2014/02/more-on-negative-interest-rates.html?showComment=1394484009721#c2472031652415480814<br />I suspect that you and Bill might agree on UOA, but perhaps not on everything here. But I'm not sure, so that's why I'm asking. Looking forward to your next post.Tom Brownhttps://www.blogger.com/profile/17654184190478330946noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-70869093030606456622014-03-10T21:23:10.095-04:002014-03-10T21:23:10.095-04:00Ok, good point. Let me re-hone my argument ... If ...Ok, good point. Let me re-hone my argument ... If Asness and Liew are consistently reporting outsized returns relative to the market, I think that it's reasonable that some part (half, 3/4, 1/50, 100/100) may be due to them bearing illiquidity/providing liquidity. JP Koninghttps://www.blogger.com/profile/02559687323828006535noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-70080425138324222652014-03-10T21:17:50.190-04:002014-03-10T21:17:50.190-04:00Yep, that's right. (Funny you ask, my next pos...Yep, that's right. (Funny you ask, my next post is on MOA. I'll try to clarify therein.)JP Koninghttps://www.blogger.com/profile/02559687323828006535noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-79178477535231070292014-03-10T17:01:12.412-04:002014-03-10T17:01:12.412-04:00The HML is a self-financing portfolio, so it's...The HML is a self-financing portfolio, so it's not exactly true that $1 "invested" would quadruple. I'm not sure how to calculate the return to HML. The $1 is probably held as treasuries in a collateral account.<br /><br />Investing $1 in the long side only would be worth much, much more than $4Charlie Clarkehttps://www.blogger.com/profile/02079017903923824877noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-40544993942723393722014-03-10T14:02:16.196-04:002014-03-10T14:02:16.196-04:00JP, O/T on one of your old posts, on your comment ...JP, O/T on one of your old posts, on your comment here in particular:<br />http://jpkoning.blogspot.com/2013/09/separating-functions-of-moneythe-case.html?showComment=1379531534519#c1295798415247681926<br /><br />Does that imply that the concept of UOA in isolation sets up a self contained system of names and symbols and relates the names and symbols to each other internal to this system with numerical ratios, but that this self contained system is not tied to any value or anything at all in the outside world? It sounds like the "definition" (which I take to be the thing which gives the UOA value in terms of an MOA) you now consider to be part of the MOA. Am I correct?Tom Brownhttps://www.blogger.com/profile/17654184190478330946noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-50123782721350837562014-03-10T13:50:47.415-04:002014-03-10T13:50:47.415-04:00Yep, good point. The on-the-run/off-the-run spread...Yep, good point. The on-the-run/off-the-run spread doesn't seem to be a very big spread. JP Koninghttps://www.blogger.com/profile/02559687323828006535noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-87443194709889199922014-03-10T13:49:26.106-04:002014-03-10T13:49:26.106-04:00"...but I would suggest not on the order of m..."...but I would suggest not on the order of magnitude that we see in book-to-market variations."<br /><br />That may be, but the HML return isn't very big to begin with. $1 invested in the strategy in 1927 is now worth just $4 or so. A weak force can explain a weak effect.JP Koninghttps://www.blogger.com/profile/02559687323828006535noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-23007202254581277072014-03-10T13:45:11.073-04:002014-03-10T13:45:11.073-04:00Ok, I see. Interesting. Similar to jt26's poin...Ok, I see. Interesting. Similar to jt26's point, I think? If the liquidity profile of stocks is deepening, and stocks that were historically illiquid are now more liquid relative to historically liquid stocks, then yes, the returns to creating selling liquidity/buying illiquidity will diminish.<br /><br />If every asset has the exact same liquidity, then there would no longer be any relatively illiquid shares that Asness & Liew could be paid to hold. <br /><br />Is that sort of what you're getting at?JP Koninghttps://www.blogger.com/profile/02559687323828006535noreply@blogger.com