The Components of the Illiquidity Premium: An Empirical Analysis of U.S. Stocks 1927-2010

51 Pages Posted: 22 Aug 2011 Last revised: 14 Feb 2013

Björn Hagströmer

Stockholm University - Stockholm Business School

Bjorn Hansson

Lund University - Department of Economics

Birger Nilsson

Lund University - Department of Economics

Date Written: January 10, 2013

Abstract

This paper estimates a conditional version of the liquidity adjusted CAPM by Acharya and Pedersen (2005) using NYSE and AMEX data from 1927 to 2010 to study the illiquidity premium and its variation over time. The components of the illiquidity premium is in this model derived as the level of expected illiquidity together with three types of illiquidity risks. We measure illiquidity of individual stocks by the efficient spread proxy developed in Holden (2009) and employ illiquidity sorted portfolios as test assets. The average annual illiquidity premium is estimated to 1.55%, the respective contributions from illiquidity level being 1.15% and from the three different illiquidity risks 0.40%. Results also indicate that commonality risk is the least important component in the illiquidity risk premium, while a component related to the hedging of wealth shocks is the most important. The illiquidity premium varies substantially over time, with peaks in downturns and crises, but with no general tendency to decrease over time.

Keywords: illiquidity level premium, illiquidity risk premium, conditional LCAPM, effective tick

JEL Classification: G12, G11, C22

Suggested Citation

Hagströmer, Björn and Hansson, Bjorn and Nilsson, Birger, The Components of the Illiquidity Premium: An Empirical Analysis of U.S. Stocks 1927-2010 (January 10, 2013). Journal of Banking and Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1913880 or http://dx.doi.org/10.2139/ssrn.1913880

Björn Hagströmer

Stockholm University - Stockholm Business School ( email )

Stockholm
Sweden

Bjorn Hansson

Lund University - Department of Economics ( email )

P.O. Box 7082
S-220 07 Lund
Sweden
+46462228668 (Phone)
+46462224118 (Fax)

Birger Nilsson (Contact Author)

Lund University - Department of Economics ( email )

P.O. Box 7082
S-220 07 Lund
Sweden

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