State-Dependent Illiquidity Premium in the Korean Stock Market

Abstract

We study the relation between the illiquidity premium and economic states in the Korean stock market. We find that aggregate market liquidity improves following real economic expansions and expansive monetary states and worsens after economic recessions and restrictive monetary states. The improved liquidity in the expansion-expansive state generates a huge illiquidity premium, while an illiquidity premium does not exist in the recession-restrictive state. As a result, the observed illiquidity premium displays strong state-dependent variations. Our empirical results indicate that a significant unconditional illiquidity premium in the Korean stock market arises due to a substantial illiquidity premium in the expansion-expansive state.

State-Dependent Stock Liquidity Premium: The Case of the Warsaw Stock Exchange

“…On the other hand, the average total liquidity premium during bear market, computed analogously to the average total liquidity premium during bull market, is equal to 0.24% monthly. Although insignificantly, total liquidity premium during bull market is higher than during bear market, supporting the previous results of Jang et al (2015) for the Korean stock market. Jang et al (2015) found that expansion-expansive state (good economic conditions) generate huge liquidity premium, while such a premium does not exist in the recession-restrictive state (bad economic conditions).…”

“…Although insignificantly, total liquidity premium during bull market is higher than during bear market, supporting the previous results of Jang et al (2015) for the Korean stock market. Jang et al (2015) found that expansion-expansive state (good economic conditions) generate huge liquidity premium, while such a premium does not exist in the recession-restrictive state (bad economic conditions). However, Jang et al's (2015) results indicate that liquidity premium displays strong state-dependent variations, while our study does not confirm that.…”

“…Extant research displays strong time-variance of stock liquidity premium conditional on market state. This is evidenced by Jang et al (2015Jang et al ( , 2017, Grillini et al (2019), and Chulia et al (2019). Our study presents no time-variance in liquidity premium conditional on market state.…”

“…Most of the extant empirical research on liquidity premium is focused on indicating the unconditional, i.e., constant over time, liquidity premium. Only recently, Jang et al (2015) analyzed state-dependent liquidity premium on the Korean stock market. They found that liquidity premium differs significantly in different market states.…”

“…To briefly summarize, studies on conditional (time-variant) liquidity premium is scarce and focused on US and other developed markets. Only the study of Jang et al (2015) is devoted to the Korean market; however, it presents an indirect approach to the distinction of market states.…”