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Economic policy uncertainty and illiquidity return premium

Hui-Ching Hsieh and Van Quoc Thinh Nguyen

The North American Journal of Economics and Finance, 2021, vol. 55, issue C

Abstract: In this study, we examine the relation between the price of liquidity, or illiquidity return premium, and the economic policy uncertainty (EPU). On average, an illiquid portfolio earns a 0.597% higher monthly return than a liquid portfolio. The results further show that the EPU index has a positive relationship with the illiquidity return premium. This indicates that investors require higher compensation for holding illiquid stocks when there is a higher economic uncertainty. We also show that EPU affects the illiquidity return premium through the market illiquidity channel. The rise of EPU could increase the risk of illiquid stocks and make investors more risk-averse, thereby requiring higher compensation for illiquidity. Finally, it is found that the relationship between EPU and the illiquidity return premium is stronger when market liquidity is impaired and during crises.

Keywords: Economic policy uncertainty; Illiquidity premium; Stock liquidity; Risk aversion (search for similar items in EconPapers)
JEL-codes: G11 G12 G18 (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecofin:v:55:y:2021:i:c:s1062940820301820

DOI: 10.1016/j.najef.2020.101291

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