Illiquidity, R&D Investment, and Stock Returns

96 Pages Posted: 2 Oct 2020 Last revised: 17 Apr 2021

See all articles by Shamim Ahmed

Shamim Ahmed

University of Liverpool Management School

Ziwen Bu

University of Birmingham - Birmingham Business School

Xiaoxia Ye

University of Liverpool Management School

Date Written: April 16, 2021

Abstract

We propose a dynamic model of research and development (R&D) venture, which predicts that the positive relation between the firm's R&D investment and the expected stock returns strengthens with illiquidity. Consistent with the model's prediction, empirical evidence based on cross-sectional regressions and double-sorted portfolios suggests a stronger and positive R&D-return relation among illiquid stocks. A further analysis shows that the important role of illiquidity in the R&D-return relation cannot be explained by factors such as financial constraints, innovation ability, and product market competition. Collectively, our results suggest that stock illiquidity is an independent driver of the R&D premium.

Keywords: Illiquidity; Research and Development Investment; Risk Premium; Stock Returns

JEL Classification: G12; G14; O32

Suggested Citation

Ahmed, Shamim and Bu, Ziwen and Ye, Xiaoxia, Illiquidity, R&D Investment, and Stock Returns (April 16, 2021). Available at SSRN: https://ssrn.com/abstract=3675865 or http://dx.doi.org/10.2139/ssrn.3675865

Shamim Ahmed

University of Liverpool Management School ( email )

Ziwen Bu (Contact Author)

University of Birmingham - Birmingham Business School ( email )

Edgbaston Park Road
Birmingham, B15 2TY
United Kingdom

Xiaoxia Ye

University of Liverpool Management School ( email )

Chatham Street
Liverpool, L69 7ZH
United Kingdom

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