The Diminishing Liquidity Premium
Indiana University - Kelley School of Business, Department of Finance
Washington University in Saint Louis - John M. Olin Business School
Tel Aviv University - Faculty of Management
September 13, 2010
EFA 2009 Bergen Meetings Paper
Previous evidence suggests that less liquid stocks yield higher average returns. Using common-stock data, we present evidence that both the sensitivity of stock returns to liquidity and liquidity premia have significantly declined over the past four decades. Furthermore, the profitability of trading strategies, based on buying illiquid stocks and selling liquid stocks, has significantly declined over this time period. Our results are robust to several conventional liquidity proxies related to volume, are not driven by size effects, and apply strongly to NYSE and NASDAQ, and weakly to AMEX. We offer possible explanations for these results, related to the proliferation of index funds and exchange-traded funds, and to enhancements in markets that facilitate arbitrage activity. Consistent with this view, we find no trend in the liquidity premium for non-common stocks and for “penny stocks,” and identify an increasing difference between the average holding periods of liquid vs. illiquid stocks.
Number of Pages in PDF File: 65
Keywords: liquidity, illiquidity, liquidity premium, stock returns
JEL Classification: G12, G14working papers series
Date posted: March 19, 2008 ; Last revised: May 14, 2012
© 2013 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo7 in 0.484 seconds