Hui Guo, Ph.D.1, Sandra Mortal, Ph.D.2, Robert Savickas, Ph.D.3, and Robert A. Wood, Ph.D.2. (1) Finance, University of Cincinnati, 418 Carl H. Lindner Hall, 2925 Campus Green Drive, Cincinnati, OH 45221, (2) Finance, Insurance, & Real Estate, University of Memphis, Fogelman College of Business & Economics, 3675 Central Avenue, Memphis, TN 38152-3120, (3) Department of Finance, George Washington University, Funger Hall, Suite 501R, 2201 G Street, N.W., Washington, D.C., 20052
Previous studies provide elusive evidence that aggregate stock illiquidity predicts excess market returns. We revisit this issue using transaction-level data over the 1984 to 2007 period to construct more precise illiquidity measures. Illiquidity alone has negligible forecasting power; however, its correlation with future market returns becomes significantly positive when in conjunction with other risk factors. Results are similar albeit weaker for less precise illiquidity measures constructed from daily data (as used in the previous studies). We document similar evidence for the long sample period 1927 to 2007, over which only low-frequency illiquidity measures are available. Moreover, the commonly used stock return predictors do not account for the forecasting power of market-wide illiquidity. Our results suggest that illiquidity risk is an important determinant of the conditional equity premium.