Illiquidity risk and equity trading performance: A statistical analysis

Abstract

Subject. The article considers the development of special statistical methods for estimating and analyzing the liquidity risk. Objectives. The purpose is to improve the methodology for statistical appraisal and analysis of risk in equity trading. Methods. The study rests both on well-known methods for equity risk analysis and my own development results (calculation of equity annual illiquidity ratio, formation of illiquidity risk factor). The data analyzed in this paper come from the Moscow Exchange (MOEX) and cover January 2011 to May 2021. The sample included all common stocks traded on MOEX and issuers’ financial statements. I also apply analysis and synthesis, induction and deduction, and methods of comparison and grouping. Results. I calculated monthly illiquidity factor as zero-investment long-short portfolio. I examined the impact of illiquidity risk on the return dynamics of size, book-to-market ratio sorted portfolios. Conclusions. The study shows that expected equity returns are related cross-sectionally to the illiquidity factor. The evidence strongly supports the hypothesis that the illiquidity risk factor is priced. The premium for this risk is positive and offers higher expected returns in equities with strong illiquidity. However, for liquid equities no significant premium is revealed. The offered approach to the factor equity risk analysis based on illiquidity risk enables a true picture of how the risks impact the equity trading performance and how they can be improved in the future.