Liquidity and Return Reversals

Pierre Collin-Dufresne and Kent Daniel

April 11, 2016

Abstract

We estimate a short term reversal process for daily US equity returns. Over our
primary sample period of 1972-2014, and for our sample of the 100 largest traded
rms, on average approximately 90% of idiosyncratic price shocks are permanent.
The remaining 10% is temporary, and decays exponentially toward zero, with a half
life of about 2.5 days. While the rate of decay (the half life) is relatively constant
over time, the reversal magnitude varies considerably over the sample. Our ndings
are consistent with the slow movement of capital(Due 2010). Also, in contrast
with previous literature, we nd no evidence that the magnitude of the temporary
component (and the pro tability of the reversal strategy) is related to market-wide
measures of illiquidity, such as the VIX. Thus, our results are consistent with a lack
of integration across capital markets.