Critical Finance Review > Vol 7 > Issue

A Review of the Return–Illiquidity Relationship

Jozef Drienko, Australian National University, Australia, Tom Smith, Macquarie University, Australia, Anna von Reibnitz, Australian National University, Australia,
Suggested Citation
Jozef Drienko, Tom Smith and Anna von Reibnitz (2018), "A Review of the Return–Illiquidity Relationship", Critical Finance Review: Vol. 7: No. .

Forthcoming: 01 Oct 2018
© 2018 J. Drienko, T. Smith and A. von Reibnitz
Liquidity and asset pricingIlliquidity risk premiumFlight to liquidity

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In this article:
1. Introduction
2. Data and Sample Selection
3. Replicated and Out-of-Sample Results
4. Robustness Modifications
5. Further Discussions of Illiquidity
6. Conclusion
Appendix A
Appendix B


Amihud (2002) shows that expected market illiquidity has a positive impact on ex ante stock returns, while the reverse relation exists between unexpected illiquidity and contemporaneous returns, suggesting the presence of a priced risk factor. We replicate these findings in-sample, but the out-of-sample results largely lose their significance and monotonic properties in the time-series. This points to a decline in the sensitivity of investors to illiquidity risk over the last two decades, a period during which technological innovations and decimalization have markedly reduced transaction costs and increased stock liquidity. Altering the measurement frequency, refining the data filters and considering alternative test specifications leads to similar results. A cross-validation approach confirms a change point in liquidity occurring post publication of the seminal study. We also show that the findings pertaining to the employed illiquidity measure are driven by scaling the numerator of the ratio by the dollar-traded volume.