Liquidity and Mispricing

53 Pages Posted: 5 Nov 2020 Last revised: 13 Apr 2022

Date Written: April 13, 2022

Abstract

Contrary to popular beliefs, the expected return of a strategy that consists of buying illiquid stocks and shorting liquid ones (i.e., the illiquidity premium) is negative. This finding occurs not only in the whole cross-section but also in each subsample controlling for size. It can be attributed to overpricing among illiquid stocks and to a lesser extent to underpricing among liquid ones. Economically, arbitrage asymmetry is the driving force behind overpricing among illiquid stocks. Thus, the interplay between illiquidity and mispricing is crucial to explain the cross-section of expected stock returns.

Keywords: Asset pricing, liquidity, arbitrage, mispricing, international stock markets

JEL Classification: G12, G14, G15, F37

Suggested Citation

Huber, Daniel, Liquidity and Mispricing (April 13, 2022). Available at SSRN: https://ssrn.com/abstract=3718411 or http://dx.doi.org/10.2139/ssrn.3718411

Daniel Huber (Contact Author)

Universität Hamburg ( email )

Von-Melle-Park 5
Hamburg, DE Hamburg 20146
Germany

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