Wednesday, June 8, 2011

Inverse Relation between Market Cap and Performance Echoes My Research

Empirical Finance Blog has an interesting post today discussed an inverse relation between market cap and performance of Magic Formula. This echoes what I have observed in my research.

According to my research, there is an inverse relation between liquidity and performance. Annualized return drops if I require more liquidity. Because large market cap generally fetch better liquidity, what I observed in my research generally echoes what Empirical Finance Blog has observed. I think 30% annualized return by Magic Formula is doable if we loosen the requirement on liquidity. However, investors may or may not be able to get rich with that because they couldn't invest too much money on a thinly traded stock. At least it is the case with my ranking system as I do weekly rebalance. But it is still arguable that if the holding period is 6 months to 1 year, investors can spend weeks or even months to accumulate a position, so liquidity may not matter.

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