quant research // summarizing the paperLOADING
Irene Aldridge · 2026-07-01
The authors measure how much a stock's price moves in response to buy/sell order flow (Kyle's price-impact coefficient) using US equity data from 2020–2025, and test whether it predicts future returns. They find that signed order flow predicts both current and next-month returns, while high volume volatility predicts lower subsequent returns. They argue the illiquidity premium arises because low order flow temporarily depresses prices that later recover, rather than from risk compensation.
Why it matters: The findings suggest order-flow and liquidity-based signals may carry cross-sectional information about which stocks outperform over the following month, which could inform factor construction or trade timing. The proposed mechanism reframes the liquidity premium as a temporary mispricing that normalizes, potentially relevant to those studying illiquidity-based strategies.
⚠ This is an academic study over a short, unusual 2020–2025 window with no live-trading or transaction-cost evidence, so predictive relationships may not persist out of sample.
We estimate Kyle's (1985) price-impact coefficient $λ$ directly from daily equity order flow and test its ability to forecast the cross-section of subsequent stock returns. Using CRSP data from 2020 to 2025, we construct firm-month measures of signed order flow and two estimators of $\hatλ_{it}$: a within-month price-impact regression and an Amihud-style ratio. Signed order flow strongly predicts contemporaneous and one-month-ahead returns, while volume volatility predicts lower subsequent returns, consistent with widening price impact degrading price discovery. Fama-MacBeth regressions confirm that our order-flow signal carries significant cross-sectional return information after Newey--West adjustment. Theoretically, we resolve the liquidity premium puzzle of Constantinides (1986) through an adverse-selection mechanism: low order flow widens $λ$ and depresses prices today; subsequent normalization restores prices, generating the illiquidity premium without risk-based compensation.
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AI summary generated from the paper’s public abstract via arXiv; it may miss nuance — read the source before relying on it. Thank you to arXiv for its open-access interoperability; StockTools is not affiliated with arXiv, and all rights remain with the authors. Educational only, not financial advice.