The Illiquidity Premium Worldwide
December 28, 2012 - Big Ideas
Can investors systematically earn a premium by holding relatively illiquid assets? In their December 2012 paper entitled “The Illiquidity Premium: International Evidence”, Yakov Amihud, Allaudeen Hameed, Wenjin Kang and Huiping Zhang examine the illiquidity premium in 26 developed and 19 emerging equity markets. They measure illiquidity as the average ratio of absolute daily stock return to trading volume (price impact per monetary volume traded). They define the illiquidity premium as the average gross return in excess of the risk-free rate for volatility-controlled portfolios that are long (short) high-illiquidity (low-illiquidity) stocks. Specifically, every three months, they: (1) sort stocks into three equal groups (terciles) based on return volatility (standard deviation of daily returns) over a lagged, rolling three-month window; (2) within each volatility tercile, sort stocks into fifths (quintiles) based on illiquidity over the same window; (3) skip one month to avoid any short-term reversal; and, (4) calculate the illiquidity premium as the average of returns of three portfolios that are long (short) the high-illiquidity (low-illiquidity) quintile within each volatility tercile. They groom the sample by excluding stocks that trade infrequently or exhibit extreme movements. They consider equal, value and monetary volume weightings for portfolios. Using daily price, trading volume and shares outstanding data for common stocks in 45 countries, along with estimates of market, size and book-to-market risk factors, during 1990 through 2011 (22 years), they find that: Keep Reading