Market Capitalization, Reversals, and the Illiquidity Premium

Abstract

We find that the illiquidity premium is mainly attributable to recent loser stocks, consistent with the possibility that it is driven, in part, by return reversals in these stocks. Among the illiquid, loser stocks, stocks that were recently sold by mutual funds subsequently show significantly greater returns than the stocks that were recently purchased, suggesting that the effect relates to a price rebound following negative price pressure. We further find that when accounting for the fact that stock liquidity is highly correlated with market capitalization, there is little evidence to suggest that an illiquidity premium extends beyond the small cap anomaly.

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