Illiquidity and Stock Returns: Evidence from the German Stock Market

Abstract

This paper examines the impact of illiquidity on equity returns on the German stock market. Since illiquidity has many facets, we cover the whole spectrum of illiquidity measures: trading speed, trading costs, trading quantity, and price impact. Based on these illiquidity measures we construct factor mimicking portfolios that capture the risk of illiquidity. Our findings provide evidence that illiquidity drives stock returns and entails a significant risk premium independent of the measure chosen. Additionally, we investigate the link between size and illiquidity and tackle the question if size proxies for illiquidity.

Keywords: Liquidity, Empirical Asset pricing, Risk premium

JEL Classification: G12