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The components of the illiquidity premium: An empirical analysis of US stocks 1927–2010

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  • Hagströmer, Björn
  • Hansson, Björn
  • Nilsson, Birger
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    Abstract

    This paper implements a conditional version of the liquidity adjusted CAPM (LCAPM). The conditional LCAPM allows for a time-varying decomposition of the total illiquidity premium into a level component and three risk components. The estimated average annual total illiquidity premium for US stocks 1927–2010 is 1.74–2.08%, which is substantially lower than in most previous studies. The contributions from illiquidity level and illiquidity risk are 1.25–1.28% and 0.46–0.83%, respectively. Of the three illiquidity risk components, risk related to the hedging of wealth shocks is the most important, while commonality risk is the least important. The illiquidity premia are clearly time-varying, with peaks in downturns and crises, but with no general tendency to decrease over time. The level premium and the risk premium are significantly positively correlated, at around 0.35; indicating that in periods of turbulence both illiquidity cost and illiquidity risk premia tend to be high.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Banking & Finance.

    Volume (Year): 37 (2013)
    Issue (Month): 11 ()
    Pages: 4476-4487

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    Handle: RePEc:eee:jbfina:v:37:y:2013:i:11:p:4476-4487

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    Web page: http://www.elsevier.com/locate/jbf

    Related research

    Keywords: Illiquidity level premium; Illiquidity risk premium; Conditional LCAPM; Effective tick;

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