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.
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This relation is confirmed for international markets by Cavenaile et al. (2014).
We tried an alternative cutoff point of at least 50 % trading days which in fact does not change our findings.
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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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Baitinger, E., Fieberg, C., Poddig, T. et al. Liquidity-driven approach to dynamic asset allocation: evidence from the German stock market. Financ Mark Portf Manag 29, 365–379 (2015). https://doi.org/10.1007/s11408-015-0257-1
- Dynamic asset allocation
- Amihud illiquidity measure
- Liquidity risk
- Investment strategy
- Out-of-sample study