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Economic policy uncertainty and illiquidity return premium

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  • Hsieh, Hui-Ching
  • Nguyen, Van Quoc Thinh

Abstract

In this study, we examine the relation between the price of liquidity, or illiquidity return premium, and the economic policy uncertainty (EPU). On average, an illiquid portfolio earns a 0.597% higher monthly return than a liquid portfolio. The results further show that the EPU index has a positive relationship with the illiquidity return premium. This indicates that investors require higher compensation for holding illiquid stocks when there is a higher economic uncertainty. We also show that EPU affects the illiquidity return premium through the market illiquidity channel. The rise of EPU could increase the risk of illiquid stocks and make investors more risk-averse, thereby requiring higher compensation for illiquidity. Finally, it is found that the relationship between EPU and the illiquidity return premium is stronger when market liquidity is impaired and during crises.

Suggested Citation

  • Hsieh, Hui-Ching & Nguyen, Van Quoc Thinh, 2021. "Economic policy uncertainty and illiquidity return premium," The North American Journal of Economics and Finance, Elsevier, vol. 55(C).
    • Handle: RePEc:eee:ecofin:v:55:y:2021:i:c:s1062940820301820
    DOI: 10.1016/j.najef.2020.101291
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    More about this item

    Keywords

    Economic policy uncertainty; Illiquidity premium; Stock liquidity; Risk aversion;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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