RFS Advance Access originally published online on January 27, 2009
Review of Financial Studies 2009 22(9):3629-3668; doi:10.1093/rfs/hhn121
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Theory-Based Illiquidity and Asset Pricing
Goizueta Business School, Emory University
School of Management, State University of New York (SUNY) at Buffalo
Anderson School, University of California
Send correspondence to A. Subrahmanyam, Anderson School of Management, University of California at Los Angeles, Los Angeles, CA; telephone (310)-825-5355; fax: (310)-206-5455; Cell: 90095-1481; E-mail: subra{at}anderson.ucla.edu.
JEL Classification: G12, G14
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Abstract |
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Many proxies of illiquidity have been used in the literature that relates illiquidity to asset prices. These proxies have been motivated from an empirical standpoint. In this study, we approach liquidity estimation from a theoretical perspective. Our method explicitly recognizes the analytic dependence of illiquidity on more primitive drivers such as trading activity and information asymmetry. More specifically, we estimate illiquidity using structural formulae in line with Kyle's (1985) lambda for a comprehensive sample of stocks. The empirical results provide evidence that theory-based estimates of illiquidity are priced in the cross-section of expected stock returns, even after accounting for risk factors, firm characteristics known to influence returns, and other illiquidity proxies prevalent in the literature.
We gratefully appreciate the constructive and thoughtful comments of an anonymous referee and Matthew Spiegel (the editor). We also thank Antonio Bernardo, Michael Brennan, Susan Christoffersen, Kee H. Chung, Na Dai, Vihang Errunza, Ruslan Goyenko, Hemantha Herath, Paul Irvine, Adam Kolasinski, Jiro Kondo, Thomas McInish, Emmanuel Morales-Camargo, Amrita Nain, Joseph Ogden, Yun Park, Christo Pirinsky, Unyong Pyo, John Schatzberg, Lawrence Southwick Jr., Jaeyoung Sung, Tony Tang, Cristian Tiu, Samir Trabelsi, Gautam Vora, Bob Welch, Dong-Chul Won, and seminar participants at Yale University, SUNY at Buffalo, Ajou University, Brock University, McGill University, California State University at Fullerton, University of New Mexico, the 2006 Annual Conference on Market Structure and Market Integrity, the 2007 KAFA–KFAs Joint Conference, the 2007 Financial Management Association Meetings, and the 2008 CICF Conference for valuable feedback. Research assistance was ably provided by Mi-Ae Kim. Huh gratefully acknowledges the generous financial support from the Social Sciences and Humanities Research Council of Canada (SSHRC) and the Faculty of Business at Brock University. All errors are solely the authors' responsibility.