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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

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.

Suggested Citation

  • Hagströmer, Björn & Hansson, Björn & Nilsson, Birger, 2013. "The components of the illiquidity premium: An empirical analysis of US stocks 1927–2010," Journal of Banking & Finance, Elsevier, vol. 37(11), pages 4476-4487.
  • Handle: RePEc:eee:jbfina:v:37:y:2013:i:11:p:4476-4487
    DOI: 10.1016/j.jbankfin.2013.01.029
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    References listed on IDEAS

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    Cited by:

    1. Amihud, Yakov & Hameed, Allaudeen & Kang, Wenjin & Zhang, Huiping, 2015. "The illiquidity premium: International evidence," Journal of Financial Economics, Elsevier, vol. 117(2), pages 350-368.
    2. repec:eee:intfin:v:51:y:2017:i:c:p:15-38 is not listed on IDEAS
    3. Isshaq, Zangina & Faff, Robert, 2016. "Does the uncertainty of firm-level fundamentals help explain cross-sectional differences in liquidity commonality?," Journal of Banking & Finance, Elsevier, vol. 68(C), pages 153-161.
    4. Saad, Mohsen & Samet, Anis, 2015. "Pricing, dynamics, and determinants of illiquidity risks: International evidence," Emerging Markets Review, Elsevier, vol. 23(C), pages 124-147.

    More about this item

    Keywords

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

    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
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes

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