Illiquidity Measure Research Articles

Illiquidity and Closed-End Country Fund Discounts

In a simple model of segmented markets and exogenous liquidity shock, the closed-end country fund premium is negatively affected by the illiquidity in the host market where shares of the country fund are traded and positively affected by the illiquidity in the home market where the underlying assets are traded. To the extent that expected and unexpected liquidity affects asset prices and returns, the closed-end country fund premium should reflect the difference between the illiquidity of the fund shares and its underlying assets. Using the Amihud measure of illiquidity, we examine this conjecture for U.S. traded single country closed-end funds, and find a strong association between the fund premium and illiquidity in both the host and home markets. Moreover, this relation is much stronger for funds investing in emerging markets where market segmentation is more likely to be binding. These funds are also more sensitive to the systematic liquidity factor, suggesting that the country fund premium may contain a significant liquidity risk premium.

Equilibrium valuation of illiquid assets

We develop an equilibrium model of illiquid asset valuation based on search and matching. We propose several measures of illiquidity and show how these measures behave. We also show that the equilibrium amount of search may be less than, equal to or greater than the amount of search that is socially optimal. Finally, we show that excess returns on illiquid assets are fair games if returns are defined to include the appropriate shadow prices.

Illiquidity and Stock Returns: Cross-Section and Time-Series Effects: A Replication

This paper replicates and extends the Amihud (2002) study that links liquidity to asset pricing. Using the current version of the CRSP dataset, we obtain essentially the same results that Amihud presents. The same methods applied to more recent data show a much weaker relation between liquidity and asset pricing. Finally, we compare the explanatory power of Amihud’s illiquidity measure to that of other simple measures that use the same data for their calculation. We find that the Amihud illiquidity measure is no better than substantially simpler measures.

Derivatives and Corporate Risk Management: Participation and Volume Decisions in the Insurance Industry

In this article, the authors analyze the derivatives holdings of U.S. insurers to empirically investigate the general hypotheses developed in the financial literature to explain why widely held, value-maximizing firms engage in risk management. The authors also develop a new hypothesis suggesting that although measures of risk and illiquidity will be positively associated with an insurer's decision to engage in risk management, these same measures of risk will be negatively related to the volume of hedging for the set of firms who choose to hedge using derivatives. The authors' analysis provides considerable support for general hypotheses about hedging by value-maximizing firms. The authors also find support for the hypothesis that, conditional on having risk exposures large enough to warrant participation, firms with a larger appetite for risk will engage in less hedging than firms with lower risk tolerance.

Another Look at Liquidity Preference

This paper shows that a precautionary demand for money can be derived in models of the state of nature variety with uncertain cash requirements even if sales of assets incur no real costs and investors are risk-neutral. The randomness of asset prices results from uncertainty about the future state of the world that determines cash requirements, hence particular market responses and ultimately equilibrium prices. Positive correlation between the amount of assets to be liquidated and the liquidation price is a sufficient condition for the derivation of an interest-elastic demand for liquidity. The correlation coefficient is a measure of illiquidity of a perfectly marketable asset. Interesting comparative static results are also derived.