Trading Imbalance, Liquidity and Stock Returns: Evidence from Brazil

Abstract The present study investigates empirically whether trading imbalances affect cross-sectional stock returns in the Brazilian market. This question is particularly important in emerging markets, where there is strong evidence that order flows of institutional investors are persistent. The main contribution of this study is to price the effect of intraday imbalances through a variable that we call TIP (Trading Imbalance Picture) in an asset pricing regression. The analysis is carried out considering variations for enhanced corporate governance listing segments, economic sectors, and risk factors. The results suggest that trading imbalance strongly predicts stock returns in the cross-section, even after accounting for risk factors, firm characteristics and other liquidity measures, and a daily difference of 1% in TIP among stocks translates into a difference in required return of 6.96% per year.