Liquidity risk, transaction costs and financial closedness: lessons from the Iranian and Turkish stock markets

Abstract

PurposeThis paper aims to study the impact of liquidity risk and transaction costs on stock pricing in Iran, a closed market operating under a financial embargo and compare the results with those of an important neighboring market, namely, Turkey.Design/methodology/approachThis study follows Liu et al. (2016) and incorporates liquidity risk and transaction costs into the traditional consumption-based asset-pricing model (CCAPM) from 2009 to 2017. Effective transaction costs are estimated a la Hasbrouck (2009) and liquidity risk according to eight different criteria.FindingsAccording to the results, both liquidity risk and transaction costs are higher in Iran, possibly due to the financial embargo. Thus, relative to Turkey, this paper should expect a higher increase in the CCAPM pricing performance in Iran when accounting for these two variables. The results are in line with this expectation and indicate that adjusting the CCAPM significantly increases its pricing performance in both countries, but relatively more in Iran.Originality/valueThis study compares liquidity risk and transaction costs in an economy under the extreme case of a financial embargo to an open yet in other important aspects similar economy from the same region.