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Liquidity Forecasts and Expected Stock Returns

  • Series
    Brown Bag Seminars in Finance
  • Speaker
    Claus Schmitt (RSM)
  • Field
  • Location
    Erasmus University, V-Building, Room VB-02
  • Date and time

    November 20, 2019
    12:00 - 13:15

Abstract: In their seminal work, Amihud and Mendelson (1986) show that higher transaction costs increase expected stock returns. Contrary to their findings, recent evidence questions the effect of stock illiquidity on expected stock returns. We present an alternative explanation for this phenomenon and argue that existing illiquidity measures do not sufficiently capture investors' expectations about future illiquidity. We develop a prediction model for future changes in stock illiquidity and test its performance out-of-sample. We find that the prediction model is able to forecast economically large and persistent changes in illiquidity. Subsequent asset pricing tests show that the effect of illiquidity on expected stock returns strongly depends on expectations about future illiquidity.