The effects of non-trading on the illiquidity ratio
Journal
Journal of Empirical Finance
Date Issued
December 1, 2015
DOI
http://dx.doi.org/10.1016/j.jempfin.2015.05.004
10.1016/j.jempfin.2015.05.004
Abstract
Using a simulation analysis we show that non-trading can cause an overstatement of the observed illiquidity ratio. Our paper shows how this overstatement can be eliminated with a very simple adjustment to the Amihud illiquidity ratio. We find that the adjustment improves the relationship between the illiquidity ratio and measures of illiquidity calculated from transaction data. Asset pricing tests show that without the adjustment, illiquidity premia estimates can be understated by more than 17% for NYSE securities and by more than 24% for NASDAQ securities.