The Pricing of the Illiquidity Factor's Systematic Risk
30 Pages Posted: 21 Mar 2014
Date Written: March 19, 2014
This paper presents a liquidity factor IML, the return on illiquid-minus-liquid stock portfolios. The IML, adjusted for the common risk factors, measures the illiquidity premium whose annual alpha is about 4% over the period 1950-2012. I then test whether the systematic risk (β) of IML is priced in a multi-factor CAPM. The model allows for a conditional β of IML that rises with observable funding illiquidity and adverse market conditions. The conditional IML β is positively and significantly priced, and remains so after controlling for the beta of illiquidity shocks.
Keywords: Liquidity factor, illiquidity premium, liquidity systematic risk
JEL Classification: G12
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