Turnover: Liquidity or Uncertainty?

Abstract

I show that turnover is unrelated to several alternative measures of liquidity risk and in most cases negatively, not positively, related to liquidity. Consequently, neither liquidity nor liquidity risk explains why higher turnover predicts lower future returns. I find that the aggregate volatility risk factor explains why higher turnover predicts lower future returns. This paper shows that the negative relation between turnover and future returns is stronger for firms with option-like equity, and this regularity is also explained by the aggregate volatility risk factor. This paper was accepted by Wei Jiang, finance.

Institutional ownership and aggregate volatility risk

“…Prior research (Barinov, 2009a(Barinov, , 2009b(Barinov, , 2009c shows that idiosyncratic volatility, market-to-book, turnover, and analyst disagreement are all negatively correlated with aggregate volatility risk, and this correlation explains their cross-sectional correlation with future returns (i.e., the anomalies in question). The story in this paper is that the anomalies are stronger in the low IO subsample, because institutions tend to avoid the firms with extremely low and extremely high levels of idiosyncratic volatility, market-to-book, turnover, or analyst disagreement.…”

“…This implies that institutions prefer firms with intermediate values of idiosyncratic volatility, market-to-book, turnover, and analyst disagreement, and the low IO subsample will include the firms with both extremely high and extremely low levels of the four variables. Thus, sorting on any of these variables in the low IO subsample will create a wider spread in the values of this variable and, since all these variables are related to aggregate volatility risk (see Barinov, 2009aBarinov, , 2009bBarinov, , 2009c), a wider spread in aggregate volatility risk. The wider spread in aggregate volatility risk makes it unsurprising that the value effect, the turnover effect, the idiosyncratic volatility discount, and the analyst disagreement effect are all stronger in the low IO subsample.…”

“…Prior research (Barinov, 2009a(Barinov, , 2009b(Barinov, , 2009c shows that firms with abundant growth options and high levels of firm-specific uncertainty beat the CAPM when expected aggregate volatility increases. This effect has two causes.…”

“…On the one hand, portfolio managers dislike the stocks with high volatility/uncertainty (see Shleifer and Vishny, 1997), which makes them decide against owning stocks with high market-to-book, high idiosyncratic volatility, high analyst disagreement, or high turnover. On the other hand, portfolio managers like the protection against aggregate volatility risk offered by the stocks with high levels of volatility and growth options 4 . Portfolio managers also recognize that they need some level of uncertainty to use their comparative advantage in access to information and in ability to process it.…”

“…Portfolio managers also recognize that they need some level of uncertainty to use their comparative advantage in access to information and in ability to process it. As a result, institutions ignore both the firms with low uncertainty (considering them unattractive) and the firms with high uncertainty (con-1 See, for example, Falkenstein (1996), Del Guercio (1996), Gompers 4 See Barinov (2009a) for the evidence that growth firms and high idiosyncratic volatility firm load negatively on the aggregate volatility risk factor, and Barinov (2009b) and Barinov (2009c) for similar evidence on high turnover firms and firm with high analyst forecast dispersion.…”