Market Illiquidity Premium on Stock Returns: An Empirical Study of Taiwan Stock Markets

Abstract

This paper examined the existence of illiquidity premiums in Taiwan stock markets during 1982-2016. First, the illiquidity premium was calculated with the method of Amihud (2014) in a whole period and its three sub periods, and then a five-factor model was formed by adding the new risk premium to the traditional Fama-French-Carhart four-factor model. Then quint portfolios the illiquidity measure by Amihud ( 2002) in an ascending order and applies factor models to explore the relationship between stock returns and illiquidity premium. The empirical results indicated that the five-factor model increased the relative explanatory power compared to the traditional four-factor model. For the higher illiquidity portfolios, the illiquidity premium demonstrated significantly positive effects on stock returns and the five-factor model showed relatively smaller alphas, which in turn proved the existence of market illiquidity premiums. The empirical results are expected to enhance the understanding of the functioning of illiquidity on developed markets in the literature, and also add more evidence on the emerging market settings.Contribution/ Originality: This paper contributes to the existing literature of liquidity study, which is mostly done on developed markets, by using the Taiwan stock exchanges, a setting of a typical emerging market. The empirical results are expected to enhance the understanding of the functioning of illiquidity in both developed and emerging markets.

Illiquidity Premium in the Indian Stock Market: An Empirical Study

“…India has the highest global mean illiquidity ratio of 3.028, followed by Poland and Romania (Amihud et al, 2019), which motivated us to study premium associated with illiquidity in the Indian stock market. This study has found that the average annual illiquidity premium for the Indian stock market stands at approximately 23%, which is quite high when compared to illiquidity premiums in other markets, such as the US -2.04% to 4% (Amihud & Noh, 2020;Keene & Peterson, 2007), Spain -2.54% (Miralles et al, 2004), Australia -4% (Chan & Faff, 2005), Vietnam -0.11% (Hoang & Phan, 2019), Indonesia -7.68% (Amanda & Husodo, 2015), and Taiwan -16% (Chen et al, 2019). High illiquidity premium in the Indian stock market suggests that stock market illiquidity is of more concern to investors in India than elsewhere.…”

“…The main objective of this paper is to price the traded illiquidity factor, which is the differential return premium on illiquid stocks over liquid stocks. The paper constructs and tests the traded illiquidity factor, which is similar to Liu (2006); Amihud et al (2019) and Chen et al (2019). Traded illiquidity tested in the paper is different from the non-traded illiquidity factor, which is a systematic risk of innovations in market illiquidity, tested by Pástor & Stambaugh (2003) and Acharya & Pedersen (2005).…”

“…The role of the market illiquidity premium factor was found to be significant and positively priced in the developed markets of US, Hong Kong, Australia and Spain (Chan & Faff, 2005;Keene & Peterson, 2007;Lam & Tam, 2011;Miralles, Quirós, & Miralles, 2004), while it is not significantly priced in the developed markets of Portugal and Norway (Leirvik, Fiskerstrand, & Fjellvikås, 2017;Miralles-Quiros, Miralles-Quiros, & Oliveira, 2017). Empirical studies on emerging markets in Vietnam, Taiwan, Croatia, Indonesia and Poland have found that the illiquidity premium factor is significant and positively priced (Amanda & Husodo, 2015;Chen, Tai, & Cho, 2019;Ganja, 2019;Hoang & Phan, 2019;Minović & Živković, 2014).…”