A Canonical Ranking of the Determinants of Share Price Liquidity

(ProQuest: ... denotes formulae omitted.)INTRODUCTIONA major purpose of all secondary markets is to provide liquidity for the securities traded on those markets. Thus, organized exchanges add efficiency to the market, and they add to the level of liquidity for shares traded on those markets. There have been many studies on the subject of share price liquidity. Kemp (2014) explained clearly how share price liquidity (SPL) would be of paramount importance to traders, but of less importance to true investors. In addition, he provided alternative methods of computing SPL and raised the question: Do illiquid stocks typically trade at lower prices? His finding was that while it appears that such discounts do exist, quantifying them is difficult. Amihud, et al. (2005) reviewed the theories on how liquidity affects the required returns of capital assets, and the empirical studies that test those theories. The authors found that theory predicts that the level of liquidity is priced, and further that the results of empirical studies found that the effects of liquidity on asset prices to be statistically significant and economically important (Amihud, et al. (2005). It would not be difficult to argue that no investor, including institutional investors, will buy any security unless they have assurance that if the need arises, they can sell those securities.The metric used in this study to measure share price liquidity is the share turnover ratio (STR). It may be defined as:STR = The Average Daily Trading Volume / The total number of outstanding shares minus those shares owned by insiders and treasury stock retained by the company (Kemp 2014). (1)Where:The average trading volume can be the average for the past 30 days or the past 10 days. Both averages are given by Yahoo Finance.Issuing companies experience different levels of demand for their equity shares and thus different levels of liquidity. That demand is a function of the perception of investors at the margin (those who are willing and able to buy). Those investors trade off basic measures of risk and return to establish that demand.The purpose of this study is to establish a financial profile of those firms identified as having the highest share turnover ratios in the database of over 5000 firms created by (Damodaran 2014) from Bloomberg, Morningstar and Compustat. Specifically, the analysis will test for significant differences in the financial profiles of firms with the highest share turnover ratios and to compare those profiles with companies selected at random. If the two groups of firms have unique financial profiles, and the model can be validated without bias, it suggests that the profile may be used as a tool to forecast companies that will maintain high STR in future periods. The use of such a new tool to forecast higher levels of liquidity would have implications for investors, managers, lenders, investment counselors, and academicians.METHODOLOGYThe issues to be resolved are first, classification or prediction, and then evaluation of the accuracy of that classification. More specifically, can firms be assigned, on the basis of selected financial variables, to one of two groups: (1) firms that were identified as having the highest share turnover ratios in their database simply referred to here as highest (HSTR) or, Firms Randomly Chosen (FRC)? That is, the firms with the very highest ratios in the database were compared firms that were randomly chosen from that same database that did not qualify for the HSTR group.Multiple Discriminant Analysis (MDA) provides a procedure for assigning firms to predetermined groupings based on variables or attributes whose values may depend on the group to which the firm actually belongs, and canonical correlation ranks those variables in order of their weighted effects on the results of the analysis. If the purpose of the study were simply to establish a financial profile of each group of firms, simple ratios would be adequate. …