The Pricing of the Illiquidity Factor's Systematic Risk
47 Pages Posted: 9 Sep 2016 Last revised: 16 Dec 2018
Date Written: December 15, 2018
We test the pricing of the systematic risk (β) of a traded illiquidity factor, the return premium on illiquid-minus-liquid (IML) stock portfolios, whose risk-adjusted return is positive and significant. We find that the risk premium of IML β is significantly higher in times of expected financial and economic distress proxied by lagged corporate bond yield spread. We further find a positive and significant risk premium on conditional IML β which is higher in times of financial and economic distress measured by the corporate bond yield spread, TED spread, or loans made by broker–dealers (including margin loans). The premium on the conditional IML β remains positive and significant after controlling for other popular liquidity-related factors’ βs and for firm characteristics, including illiquidity. In contrast, the pricing of the βs of other popular liquidity-related factors is insignificant.
Keywords: Illiquidity, Systematic Risk, Return Premium, Conditional Beta, Funding Illiquidity
JEL Classification: G12, G10
Suggested Citation: Suggested Citation