Abstract
We investigate the pricing of systematic liquidity risk in UK equities using a large sample of daily data. Employing four alternative measures of liquidity we first find strong evidence of commonality in liquidity across stocks. We apply asymptotic principal component analysis (PCA) on the sample of stocks to extract market or systematic liquidity factors. Previous research on systematic liquidity risk, estimated using PCA, is focused on the US, which has very different market structures to the UK. Our pricing results indicate that systematic liquidity risk is positively priced in the cross-section of stocks, specifically for the quoted spread liquidity measure. These findings around the pricing of systematic liquidity risk are not affected by the level of individual stock liquidity as a risk characteristic. However, counter-intuitively, we find that the latter is negatively priced in the cross-section of stocks, confirming earlier research.
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