Measuring Stock Illiquidity and Its Cross-Sectional Return Premium
Summary
This equity-factor study compares several ways to measure illiquidity and examines whether less liquid stocks earn higher subsequent returns. Its microstructure measures are quoted spread, effective spread, and price-impact lambda; it also tests Amihud’s ILLIQ measure and turnover as lower-frequency proxies. The premise is that illiquidity reflects both the concession needed for immediate execution and the price impact of an active order.
After style neutralization, the report says most measures except effective spread predict cross-sectional returns. Lambda is reported as the most stable measure, while turnover and Amihud illiquidity produce the strongest excess returns. Correlation and regression analyses suggest Amihud illiquidity can proxy for quoted spread and is related to lambda, but it does not fully explain lambda; turnover is comparatively distinct. The results are based on historical data, may not persist if market styles change, and carry implementation risk because illiquid stocks can have high market impact costs.
Key ideas
- The study compares quoted spread, effective spread, lambda, Amihud ILLIQ, and turnover as illiquidity measures.
- Most measures except effective spread show cross-sectional predictive ability after style adjustment.
- Lambda is described as the most stable measure, while turnover and Amihud illiquidity have the largest excess returns.
- Amihud illiquidity relates to spread and price impact, while turnover captures a comparatively distinct dimension.
- Historical findings may weaken as market styles change, and illiquid stocks can be costly to trade.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.