Pricing, Dynamics, and Determinants of Illiquidity Risks : International Evidence

Using the liquidity-adjusted CAPM (LCAPM) model, we estimate three time-varying illiquidity risks based on the DCC-GARCH(1,1) for 49,351 common stocks of which 20,678 trade in 60 emerging markets and the remaining 28,673 in 23 developed markets. The reported evidence from the cross-sectional regression analysis shows that the conditional LCAPM illiquidity risks are more strongly priced in emerging than developed markets and are largely determined by local factors for both markets. Our estimations show that the total annualized illiquidity risk premium in emerging markets is more than twice that in developed markets, 1.91% vs. 0.73%, respectively. Moreover, studying the dynamics of the three illiquidity risks over time, we find no time trend across all countries. We further document an increase for all three illiquidity risks during the financial crisis that is not completely reversed a year after. The illiquidity risk defined as the covariance of asset illiquidity with market returns increased more during the crisis (and decreased less a year after) in developed markets than in emerging markets. Finally, we explore the ability of business cycles, liquidity funding constraints, and the monetary policy conditions to explain the time-varying illiquidity premia. The reported results show while business cycle determinants generally have the same explanatory ability in both sets of markets, the effect of monetary policy conditions are more strongly supported in developed markets, and the liquidity funding constraints more in emerging markets