The Time-varying Relationship between Illiquidity and Stock Returns: Evidence from Germany

68 Pages Posted: 19 Apr 2021 Last revised: 11 Apr 2022

See all articles by Thomas Paul

Thomas Paul

HSBA Hamburg School of Business Administration

Abdullah Aryoubi

HSBA Hamburg School of Business Administration

Thomas Walther

Utrecht University - School of Economics

Date Written: April 18, 2021

Abstract

This study investigates the structural relationship between illiquidity and excess returns in the German stock market over time. The idea of illiquidity’s impact on asset prices has been challenged in more recent research and we provide further insight into the comprehensive picture of it. We show that illiquidity is still a significant factor when periods of financial turmoil are excluded, and longer expectation formations are considered. Departing from previous studies, we do not examine the relationship between illiquidity and excess returns in exogenously fixed observation periods but rather identify the observation periods endogenously and find the structure that illiquidity is still priced but not in times of financial turmoil. We furthermore apply different variations of Amihud’s illiquidity measure with various adjustments, including a control for Fama-French factors, and our results are robust. When investors incorporate the insight in portfolio decisions by interpreting a structural break of the relation between illiquidity and excess returns as a trading signal significantly better portfolio returns result.

Keywords: Illiquidity, Excess Return, Structural Breaks, Financial turmoil, Asset Pricing, Portfolio Management

JEL Classification: E32, G12

Suggested Citation

Paul, Thomas and Aryoubi, Abdullah and Walther, Thomas, The Time-varying Relationship between Illiquidity and Stock Returns: Evidence from Germany (April 18, 2021). Available at SSRN: https://ssrn.com/abstract=3829227 or http://dx.doi.org/10.2139/ssrn.3829227

Thomas Paul

HSBA Hamburg School of Business Administration ( email )

Adolphsplatz 1
Hamburg, 20457
Germany

Abdullah Aryoubi

HSBA Hamburg School of Business Administration ( email )

Adolphsplatz 1
Hamburg, 20457
Germany

Thomas Walther (Contact Author)

Utrecht University - School of Economics ( email )

Kriekenpitplein 21-22
Adam Smith Building
Utrecht, +31 30 253 7373 3584 EC
Netherlands

HOME PAGE: http://www.thomas-walther.info

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