Capital gains, illiquidity, and stock returns

This paper investigates the tripartite association among capital gains, illiquidity, and stock market returns. We find that trading in capital gains improves stock liquidity. We also find that realized stock returns are negatively related to the joint term of illiquidity and capital gains, but positively correlated with capital gains. These results are largely robust when we distinguish stock liquidity from unexpected liquidity. Our findings are consistent with the disposition effect and have important implications for asset pricing models and for investing.