Examining the Existence of the Characteristic Liquidity Premium: A Study of the U.S. Stock Market

Sammanfattning: This paper examines the existence of a characteristic liquidity premium among U.S. stock returns between January 1964 and December 2021 after adjusting for transaction costs. Liquidity is estimated using four different measures in order to capture different dimensions of liquidity (price impact, trading cost, trading speed, and trading quantity). When constructing long-short portfolios double-sorted on size and liquidity we find evidence of a liquidity premium among small stocks, with average gross alphas in the range of 0.85%-1.13% for NYSE depending on the specific liquidity measure used. For small stocks, the liquidity premium is found to be persistent across all subperiods considered. This holds true for all proxied dimensions of liquidity, except for trading cost for which long-short portfolios are generally found to generate negative alphas. We find adjusting for transaction costs to have limited impact on the magnitude or significance of the portfolio alphas. Standard transaction cost mitigation strategies are generally found to be inefficient in taking advantage of the liquidity premium as the reduction in transaction cost is outweighed by a reduction of the exposure to the underlying liquidity signal.