We present a liquidity factor IML, the return on illiquid-minus-liquid stock portfolios. The IML, adjusted for the common risk factors, measures the illiquidity premium whose annual alpha is about 4% over the period 1950-2012. I then test whether the systematic risk (β) of IML is priced in a multi-factor CAPM. The model allows for a conditional β of IML that rises with observable funding illiquidity and adverse market conditions. The conditional IML β is positively and significantly priced, and remains so after controlling for the beta of illiquidity shocks.
Yakov Amihud is Ira Rennert Professor of Entrepreneurial Finance at the Stern School of Business, New York University. He is the coauthor of Market Liquidity: Asset Pricing, Risk and Crises (Cambridge University Press, 2013). His research focuses on the effects of asset liquidity on value and expected return, and on the design and evaluation of securities markets' trading methods. On these topics, Amihud has done consulting work for the NYSE, AMEX, CBOE, CBOT, and other securities markets. He has published more than seventy research articles in professional journals and in books, and edited and co-edited five books on topics such as LBOs, bank M&As, international finance, and securities market design. His research also includes the evaluation of corporate financial policies, mergers and acquisitions, initial public offerings, objectives of corporate managers, dividend policy, and law and finance.
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