Kalle Rinne

A Structural Model of Short-Term Reversals

We present a structural model of the stock market where a subset of the investors is infrequently present at the market. In our model the stocks’ return reversal pattern is exponential and the amount of return reversal, the speed of return reversal and stock’s transitory volatility are all related to liquidity. In contrast to common perception, fast return reversal is typically a sign of inefficient, illiquid markets, thus not a sign of efficiency. Other results are that the stock’s return liquidity premium and the cost of immediacy to transitory investors are non-monotonic in several structural parameters of the model, such as the number of market makers. Based on the entire available return history for NYSE and Amex traded stocks, we find that, on average, 24% of NYSE and Amex traded stocks’ excess returns revert within a week, that the pattern of return reversal is exponential, and that nearly 20% of daily volatility is transitory. Both the speed of return reversal and the amount of transitory volatility depend on the stock’s liquidity: For illiquid stocks, return reversals are faster and a greater amount of the volatility, 27%, is transitory. Our estimates of the total costs of immediacy suffered by investors, as a percentage of stock’s market capitalization, are non-monotonic in stock’s liquidity.

Dash for Cash: Month-End Liquidity Needs and the Predictability of Stock Returns

We present broad-based evidence that the monthly payment cycle induces systematic patterns in liquid markets around the globe. First, we document temporary increases in the costs of debt and equity capital that coincide with key dates associated with month-end cash needs. Second, we present direct and indirect evidence on the role of institutions in the genesis of these patterns and derive estimates of the associated costs borne by market participants. Finally, we investigate the limits to arbitrage that prevent markets from functioning efficiently. Our results indicate that many investors and their agents, including mutual funds, suffer from liquidity-related trading.

Mutual Funds’ Returns from Providing Liquidity and Costs of Immediacy

We present evidence that some mutual funds systematically act as contrarian traders, and earn returns in the stock market by providing liquidity to investors that demand immediacy, while others systematically realize costs of immediacy. On average, the mutual funds’ costs of immediacy exceed their returns from providing liquidity. The funds with outflows, flows that correlate with industry flows, high market beta funds, and funds highly exposed to the momentum strategy suffer the most in costs of immediacy. The mutual funds’ average underperformance can be explained with their costs of immediacy. Finally, the funds’ historical costs of immediacy predict their alphas.