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Financial Markets and Portfolio Management

, Volume 29, Issue 4, pp 365–379 | Cite as

Liquidity-driven approach to dynamic asset allocation: evidence from the German stock market

  • Eduard Baitinger
  • Christian Fieberg
  • Thorsten Poddig
  • Armin Varmaz
Article
  • 241 Downloads

Abstract

Fluctuations in market-wide liquidity may offer opportunities of earning illiquidity premiums. For the US stock market, an investment strategy that profitably exploits these market-wide liquidity fluctuations is proposed by Xiong (J Portf Manag 39(3):102–111, 2013), who focus on an in-sample analysis. In this article, we firstly replicate the liquidity-driven investment strategy of Xiong (J Portf Manag 39(3):102–111, 2013) for the German stock market showing that a successful harvesting of illiquidity premiums is possible as well. Secondly, we extend the study design of Xiong (J Portf Manag 39(3):102–111, 2013) in that we conduct a strict out-of-sample analysis. Our results show that the initial superior in-sample results drastically deteriorate in an out-of-sample framework rendering the practical application of the liquidity-driven investment strategy for the German stock market impossible. Lastly, we modify the rather static investment methodology by a novel approach in which the asset allocation responds flexibly to market-wide liquidity fluctuations. This modification leads to significant performance improvements.

Keywords

Dynamic asset allocation Liquidity Amihud illiquidity measure Liquidity risk Investment strategy  Out-of-sample study 

JEL Classification

G11 G12 C32 C53 

Notes

Acknowledgments

We have benefited from many helpful comments by an anonymous referee and the editorial team of FMPM. Armin Varmaz acknowledges financial support from the HSB research funds (Fund Number 81811308).

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Copyright information

© Swiss Society for Financial Market Research 2015

Authors and Affiliations

  • Eduard Baitinger
    • 1
  • Christian Fieberg
    • 2
  • Thorsten Poddig
    • 2
  • Armin Varmaz
    • 3
  1. 1.FERI Trust GmbHBad Homburg v.d.HGermany
  2. 2.Chair of FinanceUniversity of BremenBremenGermany
  3. 3.Chair of International FinanceSchool of International BusinessBremenGermany

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