Price Impact Reversal and the Illiquidity Premium

Abstract

We find that a small subset of stocks with poor returns drives the illiquidity premium, consistent with it representing a return reversal. Stock transactions show that institutional investors sell illiquid losers, and that these stocks are subject to large transaction costs. The positive abnormal return associated with illiquid stocks stems directly from the reversal of the group of stocks with poor recent returns and downward price pressure. Our results suggest that these abnormal returns do not represent a broad premium that compensates investors for holding illiquid stocks. In fact, the mirror image group of illiquid winners shows an illiquidity discount.

Keywords: Illiquidity Premium, Return Reversals, Price Pressure

JEL Classification: G12, G15