FACTOR CROWDING AND LIQUIDITY EXHAUSTION

Well‐known anomalies and stable patterns in equity returns are widely employed to guide stock selection. The use of overlapping multifactor models built on these patterns induces correlated trade across investors. A stock with a strong signal from a parsimonious multifactor stock selection model exhibits changes in trade activity, net order imbalances, lower volatility, lower liquidity level, and changes in liquidity comovement consistent with correlated trade. These results illustrate that correlated trading among investors can affect the liquidity and risk of the securities they trade, and imply that measures of portfolio liquidity risk that ignore these changes can understate risk.