Stock liquidity premium with stochastic price impact and exogenous trading strategy

Szymon Stereńczak

International Review of Financial Analysis, 2020, vol. 71, issue C

Abstract: This paper provides a model which helps explain the variability of stock liquidity premium. Liquidity is modelled as a time-varying price impact and includes both permanent as well as temporary price impacts. Liquidity premium is defined as an additional expected return that stock should yield to compensate an investor for the potential loss of wealth utility caused by price impact costs. The numerical results presented show that liquidity premium varies with expected net stock return, return volatility and, to a lesser extent, with returns on risk-free bonds. Liquidity premium is a growing and convex function of liquidity costs, and temporary price impact has a more severe effect on liquidity premium than the permanent one.

Keywords: Liquidity premium; Temporary price impact; Permanent price impact; Stochastic liquidity (search for similar items in EconPapers)
JEL-codes: D61 G11 G12 (search for similar items in EconPapers)
Date: 2020
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:71:y:2020:i:c:s1057521918305702

DOI: 10.1016/j.irfa.2019.04.008

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