If you want to unload a major stock holding, wait for Tuesday. And don't even try to sell it on Friday, suggests a seminal study on broad patterns in market liquidity.
The study is one of two new ones co-authored by three academics that will be published shortly in the Financial Analysts Journal and the Journal of Finance promise to open up a new avenue for research on the nature of market liquidity.
Co-author Richard Roll, Allstate Professor of Finance at the University of California at Los Angeles's Anderson School of Management, said he hopes the research will lead to improved trading strategies and lower transaction costs. "I think people are flying in the dark now," he said.
Better understanding of the reasons for liquidity changes also will aid regulators and stock exchange officials, he added. For example, understanding liquidity could facilitate a shift to 24-hour trading, he said.
Greater understanding also could aid a move to decimalization of stock prices; in mid-1997, the New York Stock Exchange's reduction in the minimum tick size to 1/16 from 1/8 in mid-1997 hampered liquidity, Mr. Roll noted.
Mr. Roll's co-authors are Avanidhar Subrahmanyam, also a finance professor at UCLA's Anderson School; and Tarun Chordia, assistant finance professor at the Goizueta Business School at Emory University, Atlanta.
Among the major findings: Market liquidity -- the ability to buy and sell stocks in sufficient volume -- varies by the day of the week. Liquidity also is sensitive to impending macroeconomic news, market volatility and recent stock market behavior.
While previous research has focused on liquidity affecting individual stocks or examined trading patterns over relatively short periods of time, the studies look at how broad market and industry factors affect market liquidity over a long time. A third study, which still is being drafted by the three professors, will look at how order imbalances affect liquidity.
"Most knowledge about liquidity is in the form of homilies. What the authors have done is begin to systematically think about these and do some experimentation," wrote Wayne Wagner, chairman of transaction-cost monitoring firm Plexus Group Inc., Santa Monica, Calif., in an e-mail message.
Added Kevin Johnson, partner at investment manager Aronson + Partners, Philadelphia: "What they have done for liquidity is what people have done for returns for a long time."
In the first paper, to be published this month in the Financial Analysts Journal, the authors found that stocks belonging to a common industry "are likely to incur correlated trading costs."
What's more, the authors wrote that liquidity found in the market as a whole affects trading of individual stocks, regardless of capitalization size. Thus, it can be expensive for a small-cap manager as well as a large-cap manager to trade in weak markets.
While the first paper examines data only from stocks traded in 1992, the second paper covers an 11-year period through 1998, drawn from data from the Institute for the Study of Securities Markets and the New York Stock Exchange's trades and automated quotations data series.
"To our knowledge, no other study has examined such a long history of spreads, depth and trading activity, nor has any study attempted to identify their determinants," according to the second paper, which is expected to be published next April.
That study found that liquidity is strongest on Tuesdays, Wednesdays and Thursdays, with Tuesday being the most liquid day of the week. Liquidity drops the most on Fridays and before holidays -- not surprising as investors head off for the weekend.
Rich Bartels, managing director at brokerage firm Jeffries & Co., New York, explained that many investors spend the weekend readjusting their investment models, Monday analyzing the results, and then Tuesday preparing trades.
With regard to macroeconomic factors, trading activity increases prior to release of gross domestic product and unemployment figures, the study said. The depth of the market also rises, but there is little impact on bid-ask spreads. There is little reaction, however, to expected release of Consumer Price Index announcements.
Market liquidity also responds to short-term interest rates, the spread between long-term and short-term bond yields, stock-market returns and recent market volatility.
While most of the results confirm existing biases of traders, there was an important surprise in the study.
"High levels of recent market-wide volatility decrease trading activity as might have been expected, but, perhaps surprising, they also decrease spreads though depth is virtually unaffected.
"It appears that sluggish trading following recent volatility allows dealers to reduce inventory imbalances, which then prompts them to reduce spreads," the paper said.
Liquidity varies in up and down markets. While spreads between bid and sell offers decline marginally in up markets and increase strongly in down markets, depth works in the opposite direction. "This suggests that inventory accumulation concerns (of market makers) are more important in down markets," the paper said.
Added Mr. Wagner: "This is one of the first papers studying liquidity qua liquidity. It's probably more important as a harbinger that the economists are showing interest in this field than what is displayed in this paper. They should be encouraged."