The financial strength anomaly in the UK: Information uncertainty or liquidity?

This paper examines two potential key drivers of the Financial Strength (F-Score) investment strategy: Information uncertainty and liquidity. We use novel, direct measures of information uncertainty related to the variability of Financial Strength signals themselves. However, Financial Strength strategy returns are not generally strongly related to these information uncertainty proxies. We also examine two proxies for liquidity. Financial strength strategy returns are generally substantially larger for illiquid firms. A zero-cost arbitrage strategy based on F-Score generates a 20% return in illiquid UK stocks and 12% in liquid UK stocks. The enhanced F-Score effect is driven by a flight from illiquidity amongst financially weak stocks. Overall, the profitability of the F-Score investment strategy appears more closely related to liquidity than to information uncertainty.