Short-Term Reversals, Returns to Liquidity Provision and the Costs of Immediacy

Abstract

We present evidence that some mutual funds systematically act as contrarian traders, and earn returns in the stock market by providing liquidity to investors, while others systematically demand liquidity and suffer costs of immediacy. On average, the mutual funds’ costs of immediacy exceed their returns from providing liquidity. The funds with outflows, flows that correlate with industry flows, high market beta funds, and funds highly exposed to the momentum strategy suffer the most in costs of immediacy. The mutual funds’ average underperformance can be explained with their costs of immediacy. Finally, the funds’ historical costs of immediacy predict their alphas.