Abstract
This study empirically examines the illiquidity premium of Taiwan stock markets and its relationship with monetary policies. We find that commonly used illiquidity measures are generally sensitive and capable of capturing market illiquidity, particularly during the most volatile periods. Evidence shows that unconditional illiquidity is significantly priced across three illiquidity measures during the sample period. Aggregate market illiquidity innovations are noticeably affected by monetary policies. The results of Granger causality tests reveal that expansive monetary policy improves market illiquidity, whereas restrictive policy adversely affects market liquidity.Keywords: Illiquidity; illiquidity premium; monetary policy; asset pricing; Granger's causality testsJEL Classifications: G11, G12, G15DOI: https://doi.org/10.32479/ijefi.8953
Highlights
Market illiquidity commonly prevails as a systematic risk and is significantly priced among markets
This study investigates the relationship between the aggregate market illiquidity innovation and monetary policy
Unconditional Illiquidity Premium Starting with the market illiquidity premium without considering monetary conditions, we provide basic figures in this study that can be used for comparison with the literature
Summary
Market illiquidity commonly prevails as a systematic risk and is significantly priced among markets. Et al.: Illiquidity Premium and Monetary Conditions in Emerging Markets: An Empirical Examination of Taiwan Stock Markets a funding problem, the corresponding bond market liquidity considerably declines thereafter. An expansionary monetary policy causes a reduction in the liquidity premium, which is high during economic recession periods when investors require a greater compensation for holding illiquid stocks. Both the monetary policy and systematic market beta play an essential role as the determinants of liquidity commonality. We follow the argument made by Brunnermeier and Pedersen (2009) that the connection between monetary conditions and aggregate market innovations is examined through the dynamic scheme in Taiwan stock markets. The design of ILL-AV can slightly strengthen illiquidity during periods of market volatility
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