Illiquidity premium in asset returns : an empirical analysis of various liquidity measures to determine the best measure of liquidity on the Johannesburg Stock Exchange

Abstract

The choice of a liquidity measure drives the performance of a liquidity-based investment style (Moreira De Sousa, 2015). Various measures of liquidity exist, however, not all measures are applicable in every market. Through an empirical analysis of the various measures of liquidity, the best measure of liquidity in a market can be identified. The purpose of this study was to determine if liquidity based investment style, using the appropriate liquidity measure, produced profitable returns on the Johannesburg Stock Exchange (JSE) that consistently outperformed returns of the All Share index (J203T). This research project tested, six measures of liquidity; namely, Amihud (ILLIQ), Adjusted Amihud (AdjILLIQ), Relative Change in Volume (RCV), Bid-Ask Spread, Price Reversal and Turnover. A new measure of liquidly, Localized Turnover is proposed and has been tested as the seventh measure. Muller & Ward (2013) graphical time series methodology and improved data set in the style engine was used for the analysis over a period of 20 years from 1997 to 2017. Relative Change in Volume (RCV) and Localized Turnover are the only measures that produce profitable returns on the JSE. The study provided insight to which liquidity measures are applicable and profitable on the JSE and that not all liquidity measures are applicable to every market.