The Components of Illiquidity Premium: An Unobserved Components approach

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The objective of this paper is to provide a new methodology that helps to estimate the conditional liquidity-adjusted capital asset pricing model (L-CAPM) of Acharya and Pedersen (2005). Our key novelty is that we model illiquidity via Unobserved Components (UC) models to test a conditional version of the L-CAPM Model. This methodology allows to take into account the main stylised facts of liquidity time series and eliminates the look-ahead bias present in previous literature (Acharya and Pedersen, 2005, Saad and Samet, 2014, Korajczyk and Sadka, 2008, Hagstromer et al., 2013). Based on a sample containing all common firms listed on the NASDAQ from 01/012006 to 12/31/2014 we obtain the following main results. In line with previous empirical studies we founding a marginal effect of liquidity risk on returns compare to the effect of the liquidity level premium. The most important liquidity risk is related to the covariance between portfolio illiquidity and market return. But, in contraction with previous founding, liquidity risk and illiquidity level are not found to be always positively correlated (i.e. we find a negative correlation between portfolio return and market illiquidity).

Author(s):

Malick Fall    
Prolept
France

Jean-Laurent Viviani    
Université de Rennes 1
France