Liquidity and The Cross-Section of International Stock Returns

Liquidity and the Cross-Section of International Stock Returns *
Nusret Cakici †§
Fordham University
Adam Zaremba ‡
Montpellier Business School
University of Montpellier
Poznan University of Economics and Business
Abstract
We perform a comprehensive investigation of the illiquidity premium in international stock
markets. We examine several established liquidity measures in 45 countries for the years 1990–
2020. Our findings provide convincing evidence that liquidity pricing depends strongly on firm
size. Although the premium is globally present, it exists only among microcap stocks, which
have negligible economic significance. Outside the microcap universe, virtually no liquidity
effect can be observed.
Keywords: illiquidity premium, liquidity effect, international markets, microcaps, Amihud’s

measure, turnover ratio, bid-ask spread, zero-return days, asset pricing, return predictability.
JEL codes: G12, G15.
This version: March 19th, 2021
* We thank Geert Bekaert (the editor) and the anonymous referee for their valuable comments and suggestions.
The authors are also immensely grateful to Yakov Amihud, Jo Drienko, Amit Goyal, Robert Faff, Campbell R.
Harvey, Weimin Liu, Mohammad Al Momani, Szymon Sterenczak, Avanidhar Subrahmanyam, Avi Wohl, and
Hao Zhang, whose constructive feedback have significantly improved the quality of the paper. The remaining
errors (if any) are the responsibilities of the authors. Adam Zaremba acknowledges the support of the National
Science Centre of Poland (Grant No. 2016/23/B/HS4/00731).
§
Corresponding author.
†
Nusret Cakici, Gabelli School of Business, Fordham University, 45 Columbus Avenue, Room 510, New York,
NY 10023, USA, tel. +1-212-636-6776, email: cakici@fordham.edu.
‡
Adam Zaremba, 1) Montpellier Business School, 2300 Avenue des Moulins, 34185 Montpellier, France, email:
a.zaremba@montpellier-bs.com 2) Montpellier Research in Management, University of Montpellier, France; 3)
Department of Investment and Financial Markets, Institute of Finance, Poznan University of Economics and
Business, al. Niepodległości 10, 61-875 Poznań, Poland, email: adam.zaremba@ue.poznan.pl.
Electronic copy available at: https://ssrn.com/abstract=3520760

Liquidity and the Cross-Section of International Stock Returns
Abstract
We perform a comprehensive investigation of the illiquidity premium in international stock
markets. We examine several established liquidity measures in 45 countries for the years 1990–
2020. Our findings provide convincing evidence that liquidity pricing depends strongly on firm
size. Although the premium is globally present, it exists only among microcap stocks, which
have negligible economic significance. Outside the microcap universe, virtually no liquidity
effect can be observed.
Keywords: illiquidity premium, liquidity effect, international markets, microcaps, Amihud's
measure, turnover ratio, bid-ask spread, zero-return days, asset pricing, return predictability.
JEL codes: G12, G15.

1. Introduction
Liquidity is commonly regarded as a powerful and intuitive factor explaining the cross-
section of equity returns. Though liquidity is an elusive concept, it can be defined in the simplest
terms as the extent to which an investor can execute a trade without creating excessive costs.
Such costs may be explicit, such as bid-ask spreads, or implicit, such as adverse price changes
resulting from the trade. Other things being equal, less liquid stocks are more costly to trade,
making them less appealing than more liquid ones. It seems, therefore, that to compensate for
this inconvenience, investors should command some premium for holding illiquid securities.
Indeed, an ample number of studies indicate that illiquid stocks are traded at discounted
prices. Since the seminal paper of Amihud and Mendelson (1986), numerous studies have
examined the pricing of liquidity using an array of different indicators, including Amihud's ratio
(Amihud 2002), turnover ratio (Datar, Naik, and Radcliffe 1998), bid-ask spread (Chung and
Zhang 2014), number of zero-return trading days (Lesmond, Ogden, and Trzcinka 1999), or
more sophisticated approximations of trading costs (Fong, Holden, and Trzcinka 2017).
Although many articles have demonstrated that the illiquidity premium is statistically and
economically meaningful, the existing evidence has at least two substantial caveats.
First, the availability of broad international studies is limited. The evidence so far is
largely U.S.-centric or focused on individual markets.1 To the best of our knowledge, the only
large-scale global stock-level study available to an international audience is restricted to
1
See, e.g., for U.S. equities: Amihud and Mendelson (1986, 1989, 1991); Eleswarapu and Reinganum (1993);
Brennan and Subrahmanyam (1996); Chalmers and Kadlec (1997); Eleswarapu (1997); Datar, Naik, and Radcliffe
(1998); Chordia, Subrahmanyam, and Anshuman (2001); Amihud (2002); Liu (2006); Nguyen and Puri (2009);
Huh (2014); Drienko, Smith, and Reibnitz (2018); Harris and Amato (2019); Amihud (2019); and Gu, Kelly, and
Xiu (2020). For Australia: Marshall and Young (2003). For Japan: Chang, Faff, and Hwang (2010) and Li, Sun,
and Wang (2014). For frontier equities: Stereńczak, Zaremba, and Umar (2020).

Amihud et al. (2015), who examined the pricing of Amihud's ratio in 45 countries for the years
1990 through 2011. Second, several recent papers challenge the conclusions about the reliability
and pervasiveness of the illiquidity premium. Ben-Rephael, Kadan, and Wohl (2015)
demonstrate that the illiquidity premium is priced primarily among small firms and became a
second-order effect in recent years. A few studies of markets in non-U.S. countries, such as
Australia (Marshall and Young 2003) and Vietnam (Batten and Vo 2014), and frontier equities
(Stereńczak, Zaremba, and Umar 2020) are not able to confirm the positive liquidity premium.
Likewise, in the United States, Drienko, Smith, and Reibnitz (2018) demonstrate that the
relationship documented by Amihud (2002) does not hold out of the original sample. Finally,
Hou, Xue, and Zhang (2020) show that when less weight is given to microcaps in portfolio
construction, 95 of 102 liquidity measures are irrelevant for future returns.
These controversies and conflicting findings call into question the validity of the
illiquidity premium. Does liquidity really matter for stock returns? Is it a global, market-wide
phenomenon, or is it driven primarily by some group or size-class of firms? And, if it does exist,
can it be efficiently exploited? In this article, we attempt to shed some light on these issues.
Our paper aims to make two major contributions to the literature. First and foremost, we
conduct a wide-ranging evaluation of liquidity pricing in the cross-section of returns in
international equity markets. To this end, we investigate the performance of firms from 45
developed and emerging stock markets around the world for the period 1990-2020. To the best
of our knowledge, our study is the most comprehensive evaluation of the illiquidity premium
ever performed. Second, we investigate the unique role of small firms in the observed liquidity
effect. Specifically, we want to see whether the illiquidity premium is a widespread market
phenomenon, or whether it comes only from a handful of small and hardly investable firms. By
examining this, we not only help to understand the sources of the liquidity effect, but we also
provide insights into its significance.

To answer these questions, we conduct a series of comprehensive tests of the illiquidity
premium in the global equity market. Using three decades of international data, we employ
three different major methods: examinations of illiquidity premium portfolios, cross-sectional
regressions, and bivariate sorts. While our primary liquidity measure is Amihud's (2002)
illiquidity ratio, we ascertain the robustness of our findings with three supplementary measures:
turnover ratio (Datar, Naik, and Radcliffe 1998), bid-ask spread (Chung and Zhang 2014), and
the proportion of zero-return days (Lesmond, Ogden, and Trzcianka 1999).
We start with cross-sectional regressions that examine the relationship between
international stock returns and firm-level liquidity. Besides the regular approach, we use two
methods of controlling for company size. First, we perform a separate analysis within
subsamples of bigger firms and microcaps, defined as those with a market capitalization above
and below an inflation-adjusted value of USD 500 million, respectively. Second, following
Hou, Xue, and Zhang (2020), we substitute ordinary least-squares estimation with a weighted
least squares method that takes into account firm size. The results of the cross-sectional
regressions lead to an unequivocal conclusion: although the illiquidity premium is strong and
robust in international equity markets, it is driven primarily by microcaps. After we control for
their role, no premium can be confirmed. Let us reiterate this: there is no evidence of an
illiquidity premium among the large companies constituting the vast majority of international
investable equity markets. These results hold for global, developed, and emerging markets, and
are robust to different methods of controlling for company size, alternative liquidity proxies,
and inclusion of a battery of control variables. To sum up, the pricing of liquidity is driven by
very small companies—frequently referred to as microcaps—that have limited economic
importance.
We next turn to tests of portfolios from bivariate sorts on size and liquidity. Specifically,
we take 25 portfolios constructed from two-way dependent sorts and evaluate their performance

in global, developed, and emerging markets. Again, this exercise provides convincing evidence
that the entire illiquidity premium is driven by the quintile of the smallest companies, which
exhibit negligible economic importance. Within this market segment, constituting
approximately 0.2% of market capitalization globally, the premium is powerful and sizeable.
Outside the tiniest firms, however, practically no significant overperformance of illiquid firms
is observed. This final observation holds for almost all types of markets—global, developed,
and emerging—as well as for several different liquidity measures. Given that the illiquidity
premium comes from very small stocks representing a marginal fraction of the market,
capturing it with quantitative strategies may pose severe challenges in practice.
The study most closely related to ours is Amihud et al. (2015), who investigate the
illiquidity premium for stocks in 45 countries. It is also linked with the paper by Bekaert,
Harvey, and Lundblad (2007), who concentrated on emerging markets. However, our additional
analysis includes the examination of firm size, and we are the first to comprehensively
demonstrate its essential role in the development of the illiquidity premium in broad global
international markets.2 Hence, we also contribute to the research on the robustness of the
illiquidity premium (e.g., Ben-Rephael, Kadan, and Wohl 2015; Drienko, Smith, and Von
Reibnitz 2017; Hou, Xue, and Zhang 2020) by providing new international evidence on the
contribution of microcaps to the illiquidity premium.
The remainder of the article proceeds as follows: Section 2 discusses the data and
variables. Section 3 presents the cross-sectional regressions. Section 4 reports the results of the
univariate and bivariate sorts. Finally, Section 5 concludes the study.
2
As one of the robustness checks, Amihud et al. (2015) remove the smallest 10% of companies, but this is not
enough since the number of small firms is large.

2. Data and Variables
In this section, we describe the data used in our study. We begin with an outline of the
data sources and samples, and we continue with descriptions of the liquidity measurement
methods and variable calculations.
2.1. Data Sources and Sample Preparation
We use firm-level data from the 45 countries examined by Amihud et al. (2015). The
sample contains 26 stock markets classified as developed (Australia, Austria, Belgium, Canada,
Cyprus, Denmark, Finland, France, Germany, Greece, Hong Kong, Israel, Italy, Japan,
Netherlands, New Zealand, Norway, Portugal, Singapore, South Korea, Spain, Sweden,
Switzerland, Taiwan, U.K., USA) and 19 classified as emerging (Argentina, Bangladesh,
Brazil, Chile, China, Egypt, India, Indonesia, Malaysia, Mexico, Pakistan, Peru, Philippines,
Poland, Romania, South Africa, Sri Lanka, Thailand, Turkey). Similar to numerous other
international asset pricing studies (e.g., Chui, Titman, and Wei 2010; Griffin, Hirschey, and
Kelly 2011; Griffin, Kelly, and Nardari 2010; Hou, Karolyi, and Kho 2011; Jacobs 2016; Jacobs
and Müller 2020), our primary source of international stock price and accounting data is
Datastream. The comprehensive coverage provided by Datastream is comparable to that of
Bloomberg, which is used by, e.g., Fama and French (2012, 2017), but Datastream allows for
easier research replication. The study period runs from January 1990 to April 2020,
encompassing many remarkable events such as the global financial crisis of 2008 and the start
of the COVID-19 pandemic in 2020. Nevertheless, because some of the variables and factors
used in this study require prices or accounting information from earlier periods, we also use
historical data dating back to December 1987.

To cope with all the issues related to exchange rate risk, all the returns throughout the
paper are expressed in U.S. dollars. Consistent with this, the excess returns are calculated
relative to the one-month U.S. T-bill rate (obtained from French [2020]).
Our sample comprises all stocks available in Datastream, including both listed and
delisted ones, to avoid survivorship bias. Although Datastream offers vast amounts of
international data, the quality of its data is uneven, and adjustments and filtering are required
to mitigate certain errors (Ulbricht and Weiner 2005; Ince and Porter 2006; Tobek and Hronec
2018). To ensure the quality of our sample, we apply a series of static and dynamic filters. First,
we focus only on common stocks, discarding all unit trusts, investment trusts, closed-end funds,
convertible securities, American depositary receipts (ADRs), and warrants from the sample.
Specifically, we take only primary quotes of major securities listed in the markets. Second, for
each country's equity list, we verify the given geographical location and the currency of the
firms. For example, for British securities, the currency must be given as the British pound and
the geographical location of the firm must be the United Kingdom. Third, we require all firms
to have the book value of their equity available for the prior six months. Fourth, we delete
extreme returns. To be specific, when dealing with daily data (e.g., for variable calculation), we
discard returns exceeding 100%; when monthly returns are involved, we drop observations
above 500%. Fifth, we rely on Datastream Worldscope datatypes to avoid look-ahead bias in
accounting data. Sixth, we download the prices and total return indices with five decimal places
to alleviate the return errors stemming from foreign exchange conversions. Finally, to align our
study with previous papers and ensure comparability, we closely follow Amihud et al. (2015)
and, for the United States, we use only NYSE and AMEX stocks.3 Having applied all these
3
Amihud argues that because trading on the NASDAQ in the past was mainly through market makers, the
NASDAQ volume is not comparable with NYSE and AMEX trading, resulting in incomparable liquidity ratios.
The NYSE and AMEX are also separated from the NASDAQ in Brennan, Huh, and Subrahmanyam (2013).

filters and adjustments, the sample consists of 86,462 companies (62,406 and 24,056 from
developed and emerging markets, respectively).4 Figure 1 presents the precise number of stocks
in the sample through time.
[Insert Figure 1 here]
2.2. Liquidity Measurement
Stock liquidity is a broad and elusive concept. Overall, the level of liquidity can be
defined as the extent to which an investor can buy or sell a large number of shares at any cost,
at any time, and without causing unfavorable price movements. This definition implies several
different dimensions, such as quantity (depth), time (immediacy), price impact (resiliency), and
cost (tightness). All these dimensions cannot be easily captured by a single liquidity metric
(Chou, Ko, and Wei 2013; Sarr and Lybek 2002), and different measures may lead to different
conclusions regarding the liquidity level (Kim and Lee 2014; Korajczyk and Sadka 2008; Sarr
and Lybek 2002; Yeyati, Van Horen, and Schmukler 2008). Hence, to ensure a comprehensive
and robust perspective, we use three different liquidity measures in our analyses.
In the selection of our baseline liquidity measure, we follow Amihud et al. (2015) and
rely on the popular Amihud's (2002) ratio (ILLIQ), reflecting the price impact dimension of
liquidity:
1 𝑁𝑜𝑇𝐷𝑖,𝑡 |𝑟𝑖,𝑡,𝑑 |
𝐼𝐿𝐿𝐼𝑄𝑖,𝑡 = 𝑁𝑜𝑇𝐷 ∑𝑑=1 , (1)
𝑖,𝑡 𝐷𝑉𝑜𝑙𝑖,𝑡,𝑑
4
Importantly, the finance literature offers several different cleaning methods and procedures (see, for example,
Ince and Porter (2006) and Griffin, Kelly, and Nardari (2010)). Hence, we also experiment with alternative and
additional filters. For example, we drop the extreme negative returns to account for return reversals, or eliminate
the securities with prices not exceeding 1 U.S. dollar. We also consider alternative limits for extreme returns. None
of these operations influences qualitatively the essential conclusion from this paper that there is no evidence for
the illiquidity premium in the big and medium-sized firms constituting almost all of the total market capitalization.

where ri,t,d denotes the daily return on stock i on day d, DVol is the daily dollar volume, and
NoTD indicates the number of trading days in a given market during the measurement period
(trailing 12 months in the baseline approach). The subscript t refers to a particular estimation
period ending in a given month, t. A higher value of ILLIQ indicates a lower level of liquidity
(i.e., greater illiquidity).
For the sake of robustness, we supplement the analyses using ILLIQ with three
additional illiquidity proxies. The quantity dimension of liquidity is captured with the turnover
ratio (TURN), as in Datar, Naik, and Radcliffe (1998). The turnover ratio for security i at time
t is measured as follows:
1 𝑁𝑜𝑇𝐷𝑖,𝑡 𝑀𝑉𝑖,𝑡,𝑑
𝑇𝑈𝑅𝑁𝑖,𝑡 = 𝑁𝑜𝑇𝐷 ∑𝑑=1 , (2)
𝑖,𝑡 𝐷𝑉𝑜𝑙𝑖,𝑡,𝑑
where DVol denotes the dollar trading volume, and MV is the market capitalization (i.e., the
number of shares outstanding multiplied by price). Let us highlight that we use an inverse of
the original turnover ratio of Datar et al. (1998). This is to make sure that all our liquidity ratios
order firms in a consistent fashion. In consequence, a higher value of TURN in our study
indicates greater illiquidity.
The cost dimension of liquidity is captured by the bid-ask spread (BAS), calculated as
in Chung and Zhang (2014):
1 𝑁𝑜𝑇𝐷𝑖,𝑡 𝑎𝑠𝑘𝑖,𝑡,𝑑 −𝑏𝑖𝑑𝑖,𝑡,𝑑

𝐵𝐴𝑆𝑖,𝑡 = 𝑁𝑜𝑇𝐷 ∑𝑑=1 (3)
𝑖,𝑡 𝑚𝑖𝑑𝑖,𝑡,𝑑
where ask and bid denote ask and bid prices, respectively, and mid is their average. We compute
BAS using only the days when the bid and ask prices are available. Also, we omit days with
negative or zero values of spread and BAS observations with a spread exceeding 20%. Finally,
the stock must have a minimum number of daily observations of 15, 45, 90, and 150 for the 1-
month, 3-month, 6-month, and 1-year BAS, respectively. A higher value of BAS indicates a
lower level of liquidity.
10

Our last liquidity measure is the proportion of zero-return days (ZERO) developed by
Lesmond, Ogden, and Trzcinka (1999), and advocated by Bekaert, Harvey, and Lundblad
(2007), among others:
𝐷 𝑟=0
𝑖,𝑡
𝑍𝐸𝑅𝑂𝑖,𝑡 = 𝑁𝑜𝑇𝐷 , (4)
𝑖,𝑡
𝑟=0
where 𝐷𝑖,𝑡 represents the number of zero-trading days.
Our measures belong among the most popular and best-established liquidity indicators
(Ma, Anderson, and Marshall 2016) for at least three reasons. First, they are intuitive and easy
to understand. Second, they are simple to compute, facilitating replication studies and practical
applications. Third, they fare favorably in survey studies performing evaluation and comparison
of different liquidity measures against liquidity benchmarks. For example, Lesmond (2005),
Marshall, Nguyen, and Visaltanachoti (2013) and Fong et al. (2017) compare several metrics
and advocate Amihud's ratio as one of the prime measures for stock-level liquidity comparisons.
Also, Fong, Holden, and Trzcinka (2017) argue that the daily percent quoted spread (Chung
and Zhang 2014) is the best percent-cost liquidity proxy for global research. Finally, Ma,
Anderson, and Marshall (2016) in their review study conclude that, for international studies,
the closing percent quoted spread is the best spread cost proxy and Amihud's measure is the
best price impact proxy.
In our baseline approach, all three liquidity measures are estimated based on a 12-month
trailing period, as in the seminal study of Amihud (2002). In other words, we predict the return
for month t based on the liquidity measures derived from months t-12 to t-1. Nevertheless, our
results do not depend on this particular choice. In an additional unreported analysis, we also
experiment with one-, three-, and six-month trailing periods. Our conclusions remain intact and
robust to different windows.
Figure 2 provides an overview of changes in average liquidity (measured with ILLIQ
and BAS) through time. Several features stand out. First, liquidity is lower in emerging markets
11

than in developed markets. Second, the liquidity—especially measured with ILLIQ—is highly
variable through time, with remarkable spikes. In particular, illiquidity jumps during major
crises. The average ILLIQ level recorded its maximum values during the 1998 Russian crisis
and the global financial crisis of 2008. Third, as illustrated by the pattern in BAS, the liquidity
generally improves over time.
2.3. Control Variables
In addition to the liquidity proxies outlined above, we control for a battery of the most
well-established return predictors from the asset pricing literature. The size effect (MV) is
proxied by the logarithm of the stock market capitalization at the end of the previous month
(Banz 1981), where the capitalization is the product of the number of shares outstanding (in
USD million) and the price per share. The book-to-market ratio (BM) is calculated as the six-
month lagged book value of equity divided by the most recent market value of equity
(Rosenberg, Reid, and Lanstein 1985). The book value represents the value of the last reported
common equity; preferred stock is included where it participates with ordinary shares in the
company's profits and otherwise is excluded and deducted at par value. The momentum effect
(MOM) is represented by the total stock return in months t-12 to t-2 (Jegadeesh and Titman
1993; Fama and French 1996). The short-term reversal (REV) effect, documented by Jegadeesh
(1990) and Lehnmann (1990), is the total stock return over the prior month (t-1). The stock
market beta (BETA) is computed as the slope coefficient on the regional (developed or
emerging) stock market over a trailing 36-month period. Specifically, to derive BETA for month
t, we regress the stock excess returns in months t-36 to t-1 on the excess return on the value-
weighted portfolio of all the firms in the relevant country stock market.
12

The idiosyncratic risk (IVOL) is the residual term derived from the Fama-French (1993)
three-factor model as in Ang et al. (2006):

𝐹𝐹 𝑀𝐾𝑇 𝑆𝑀𝐵 𝐻𝑀𝐿
𝑅𝑖,𝑡 = 𝛼𝑖,𝑡 + 𝛽𝑖,𝑡 𝑀𝐾𝑇𝑡𝐿 + 𝛽𝑖,𝑡 𝑆𝑀𝐵𝑡𝐿 + 𝛽𝑖,𝑡 𝐻𝑀𝐿𝐿𝑡 + 𝜀𝑖,𝑡 , (5)
where 𝐻𝑀𝐿𝐿𝑡 , 𝑆𝑀𝐵𝑡𝐿 , and 𝐻𝑀𝐿𝐿𝑡 indicate the returns on the local market, small-minus-big, and
high-minus-low factors, respectively, calculated for individual countries according to the
procedures in Fama and French (2012). Specifically, we compute the factor returns following
the methodological approach described in Table A1, but using data only from the local stock
market where the company is listed. The IVOL variable is calculated based on 36 months of
data.
The conditional skewness for stock i in month t (COSKEWi,t) is derived based on a time-
series regression following Harvey and Siddique (2000) using trailing 36 months of returns
(𝑅𝑖,𝑡 ):
0 1
𝑅𝑖,𝑡 = 𝛽𝑖,𝑡 + 𝛽𝑖,𝑡 𝑀𝐾𝑇𝑡𝐿 + 𝐶𝑂𝑆𝐾𝐸𝑊𝑖,𝑡 (𝑀𝐾𝑇𝑡𝐿 )2 + 𝜀𝑖,𝑡 . (6)
0 1
where 𝑀𝐾𝑇𝑡𝐿 is the local stock market excess return, 𝜀𝑖,𝑡 denotes the error term, and 𝛽𝑖,𝑡 , 𝛽𝑖,𝑡 ,
and 𝐶𝑂𝑆𝐾𝐸𝑊𝑖,𝑡 are the estimated regression parameters.
Operating profitability, OP, (Fama and French 1996; Ball et al. 2015) is defined as EBIT
divided by book-value to equity. Company investment (AG) is estimated as in Cooper, Gulen,
and Shill (2008), that is, as the annual growth in total assets, measured by the change in the
book value of assets lagged by six months, i.e., in months t-19 to t-7.
Table 1 presents the basic statistical properties of the major variables used in this study.
Most notably, our prime liquidity measure has a highly non-normal distribution, exhibiting
elevated skewness and kurtosis. It does not display a major correlation with other variables, and
the majority of the pairwise correlation coefficients between ILLIQ and other control variables
are very low. Two remarkable exceptions are the positive relationship between ILLIQ and
13

IVOL, previously noted by Amihud et al. (2015), as well as the negative correlation with firm
size. The last observation is intuitively understandable since small firms tend to be less liquid.
[Insert Table 1 here]
3. Cross-Sectional Regressions
We begin our investigations of the liquidity effect in global markets with cross-sectional
regressions following Fama and MacBeth (1973). This exercise aims to check whether the
liquidity proxies predict the future monthly returns in the cross-section:
𝑗
𝑅𝑖,𝑡+1 = 𝛾0 + 𝛾𝐼𝐿𝐿𝐼𝑄 𝐼𝐿𝐿𝐼𝑄𝑖,𝑡 + ∑𝑛𝑗=1 𝛾𝐾 𝐾𝑖,𝑡 + 𝜀𝑖,𝑡 , (7)
where Ri,t+1 is the excess return on the stock i in month t+1, ILLIQi,t denotes the Amihud
illiquidity measure in month t (defined as in Section 2.2), εi,t is the error term, and γ0, γILLIQ, and
𝑗
γK are monthly regression parameters. 𝐾𝑖,𝑡 refers to the set of additional control variables listed
in Section 2.3: MV, BM, MOM, BETA, REV, IVOL, COSKEW, PROF, and AG.5 For robustness,
we perform both univariate regression with no control variables included, and multivariate tests
accounting for the role of other stock return predictors. We conduct these tests for global,
developed, and emerging markets.
In this study, we are particularly interested in the role of firm size in liquidity pricing.
Therefore, we perform our examinations in three different subsets. The first is comprised of all
firms in our equity universe. The second focuses on larger companies only, discarding the
stocks from the smallest companies that have only minor economic relevance from a practical
5
Amihud et al. (2015) argue that ILLIQ is correlated with the volatility of returns. Our baseline multivariate
regressions control for idiosyncratic volatility (IVOL) and beta (BETA), which are the building blocks of total
return volatility. Nonetheless, to ensure the robustness of our findings we also experiment with replacing
idiosyncratic volatility with total volatility. This operation leads to no qualitative change in our overall results. For
brevity, we do not report this finding in further detail.
14

perspective. To differentiate between the larger firms and microcaps, we set the cutoff level at
the real value of USD 500 million, inflation-adjusted to December 31st, 2019.
Noteworthy, our threshold of inflation-adjusted USD 500 million is broadly aligned
with academic perspective and investment practice. Though there is no uniformly acclaimed
definition of microcaps, typically, this class comprises firms below USD 300 to 500 million
market capitalization (see, e.g., Kennedy 2005; Rabener 2018). Investopedia (Chen 2020) refers
to microcaps as to stocks below USD 300 million. On the other hand, as of January 2021, the
average and median firm size in the Russel Microcap Index equals USD 1,886 and 282 million,
respectively (Russel 2021). Also, Hou, Xue, and Zhang (2020) define microcaps as stocks
below the 20th percentile of the NYSE market equity, and the cutoff point at the end of 2016
amounts to USD 724 million. In Fama and French (2008), who follow a similar classification,
the end-of-study period (June 2005) threshold for microcaps is USD 610 million. Our limit of
inflation-adjusted USD 500 million falls within the range of popular microcap definitions.
To obtain the sample of the bigger firms, we adjust the value of USD 500 million from
December 2019 for each month of our study period using the U.S. Consumer Price Index
obtained from the U.S. Bureau of Labor Statistics (2020), and from the sample for each month
we drop all the companies with a market capitalization below this threshold. Finally, the third
subset comprises the microcaps only, i.e., the firms below the inflation-adjusted value of USD
500 million.
Companies with a market value below USD 500 million are commonly regarded as
microcaps by market practitioners and do not fall within the typical investable universe of
mainstream equity funds. In consequence, their economic relevance is limited. Figure 3 displays
the proportion of the aggregate market capitalization of our sample that is represented by
microcaps. The fraction of the market comprised of small companies oscillates around 4% in
our global sample. It is slightly lower in developed markets and higher—approximately 10%—
15

in emerging markets. This fraction usually rises following bear markets, when stock prices and
firm capitalizations fall, and drops during bull periods.
In our baseline framework, the regressions are applied to all firms in the sample, and the
coefficients are estimated using the ordinary least squares (OLS) method. We denote this
approach AF-OLS. To account for the role of firm size, we apply the cross-sectional regressions
also to the subsets of bigger companies and microcaps, marking these approaches as BF-OLS
and MF-OLS. If the illiquidity premium is driven by the smallest firms in the markets, we would
expect it to be strong (weak) in the micro (bigger) company subset.
Besides splitting the full sample into the two capitalization subsets, for robustness, we
also employ an alternative approach of controlling for the firm size. Specifically, we follow the
arguments in Hou, Xue, and Zhang (2020) and calculate weighted least squares (WLS)
regressions for all the firms (AF-WLS). The classic OLS regressions are dominated by small
stocks because of their prevalence in the stock market: there are simply many more small firms
than large firms. The OLS regressions impose a linear function on the relationship between
stock returns and independent variables. In addition, the procedure of minimizing the sum of
squared errors may assign more weight to stocks with extreme characteristics or volatile returns.
These outliers are most likely to be very small firms, so the role of micro- and nano-caps is
strongly emphasized. Applying WLS with weights linked to market values mitigates these
problems. In line with this, Harvey and Liu (2020) also indicate that value-weighted estimates
from cross-sectional regressions effectively capture their economic significance.
The results of the cross-sectional regressions are reported in Table 2. Panel A focuses
on global markets. When we apply the OLS approach to all the firms in the sample
(specification [1]), ILLIQ helps to predict future returns in the cross-section. The slope
coefficients on ILLIQ are positive and remain significant in univariate tests and when we control
16

for a battery of additional return predictors. Importantly, in an unreported analysis, we also
scrutinize different subsets of all our full set of control variables. The conclusions remain
identical and unaffected in all different specifications: ILLIQ retains its predictive abilities.
Noteworthy, the picture changes when we split the sample into larger firms and
microcaps. For the microcaps (specification [3]), the coefficient remains high and strongly
significant. However, for the bigger firms (specification [2]), the predictive ability of ILLIQ
disappears, and the slope coefficient is no longer significantly different than zero. In other
words, the ILLIQ coefficient matters for the smallest firms with a market value below USD 500
million, but it appears irrelevant for the remaining companies. Again, this markedly diminishes
the economic significance of the illiquidity premium.
Finally, the AF-WLS approach of Hou, Xue, and Zhang (2020) with weights linked to
market values, which uses a different method to account for the firm size, leads to identical
conclusions. When we consider companies' capitalizations in the regression, the role of ILLIQ
becomes irrelevant. The whole illiquidity premium appears to be driven purely by the
microcaps.
Panels B and C of Table 2 concentrate on developed and emerging markets separately.
The developed markets (Table 2, Panel B) follow the same pattern as the global sample. The
ILLIQ factor plays a major role in the AF-OLS approach (specification [5]), with high t-statistic
values, even exceeding 3 in the multivariate tests. Nonetheless, the effect is driven purely by
small firms. After we control for these, either by discarding the small companies from the
sample (specification [6]) or by applying WLS regressions of Hou, Xue, and Zhang (2020)
(specification [8]), any cross-sectional relationship between ILLIQ and future returns vanishes.
The association between ILLIQ and performance survives only in the microcap subset
(specification [7]). Moreover, for emerging markets, the role of ILLIQ seems even weaker.
17

Admittedly, the slope coefficients are nominally higher in the univariate tests, but none is
significant, in either the bigger firms or microcaps subset.6
Overall, the results so far cast substantial doubt on the validity of the illiquidity
premium. To further corroborate these findings, let us now turn to alternative liquidity proxies.
Although the findings in Table 2 appear robust, they may be illiquidity-measure specific. To
exclude such a possibility, we replicate the cross-sectional tests from Table 2 using three
alternative metrics described in Section 2.2: TURN, BAS, and ZERO. The outcomes of these
exercises are displayed in Table 3. For brevity, we report only the slope coefficients of the
liquidity measures.
The major conclusions are broadly consistent with what we have seen for ILLIQ with
the other analyses: no liquidity premium is recorded for the biggest companies with a market
capitalization exceeding USD 500 million. Nevertheless, we observe some interesting
variations among the liquidity proxies. BAS proves a powerful predictor, with t-statistics
exceeding 7 or 8, depending on the specification. ZERO also predicts very well, and its
statistical significance is higher than for ILLIQ. Furthermore, unlike ILLIQ, these two
measures—BAS and ZERO—successfully forecast returns in emerging markets as well as
developed markets (except for multivariate regressions with ZERO). Nonetheless, as with the
results from the cross-sectional regressions reported in Table 2, they lose any importance when
we account for firm size. When we control for the role of the smallest firms through either
6
Ben-Rephael, Kadan and Wohl (2015) recommend using an inflation-adjusted version of Amihud’s ratio that
accounts for changes in overall price level in the economy. To assure the robustness of our findings, we reproduce
our cross-sectional regressions closely following the liquidity measurement formula in Ben-Rephael, Kadan and
Wohl (2015). The results of this test are reported in Table A4 in the Online Appendix. This methodological change
has no influence on our overall findings.
18

subsample analysis or WLS regressions of Hou, Xue, and Zhang (2020) with weights linked to
market values, the slope coefficients on the illiquidity measure no longer reliably depart from
zero.
Finally, the link between share turnover (TURN) and future returns is even weaker than
those seen for the other predictive variables. Literally, in none of the specifications does TURN
positively relate to expected returns. This may support the views expressed in Barinov (2014)
and Avramov, Chordia, and Goyal (2006) that turnover does not capture pure stock liquidity,
but a separate, different asset-pricing phenomenon.
4. Bivariate Sorts on Size and Liquidity
Having established the basic return patterns with the cross-sectional regressions, we
now turn to portfolio sorts. We follow the suggestions of Fama (2015), who argues that both
time-series and cross-sectional tests provide unique insights and thus should be examined
jointly. In this study, we use double sorts that allow us to effectively control for the role of firm
size in the liquidity effects. The analyses of portfolios from two-way dependent sorts on market
value and liquidity enable us to precisely see the role of different company capitalization on the
illiquidity premium development.
In this experiment, we first sort all the firms into quintiles based on their total market
value at month t-1. Subsequently, within each size group, we sort the stocks into five quintiles
based on ILLIQ. Next, based on individual subsets, we form equal-weighted portfolios from
bivariate sorts on size and liquidity (the results for value-weighted portfolios are available upon
request). Finally, we construct long-short portfolios that buy (sell) the firms with the highest
(lowest) ILLIQ. Their performance serves as a simple and intuitive check of the monotonic
patterns associated with liquidity in stock returns.
19

To account for the role of other regularities in equity returns, we evaluate the portfolio
performance with a six-factor model in the style of Fama and French (2018):
𝑅𝑡 = 𝛼 + 𝛽𝑀𝐾𝑇 𝑀𝐾𝑇𝑡 + 𝛽𝑆𝑀𝐵 𝑆𝑀𝐵𝑡 + 𝛽𝐻𝑀𝐿 𝐻𝑀𝐿𝑡 + 𝛽𝑊𝑀𝐿 𝑊𝑀𝐿𝑡 + 𝛽𝑅𝑀𝑊 𝑅𝑀𝑊𝑡 +
𝛽𝐶𝑀𝐴 𝐶𝑀𝐴𝑡 + 𝜀𝑡 , (8)
where Rt denotes the excess stock return in month t; εt indicates the residual term; and α, βMKT,
βSMB, βHML, βWML, βRMW, and βCMA are estimated regression coefficients. MKTt, SMBt, HMLt,
WMLt, RMWt, and CMAt represent monthly returns on factor portfolios: market excess return
(MKT), small-minus-big (SMB), high-minus-low (HML), winners-minus-losers (WML), robust-
minus-weak (RMW), and conservative-minus-aggressive (CMA). Notably, our six-factor model
nests several other popular asset-pricing models, such as the CAPM (Sharpe, 1964), the three-
factor model of Fama and French (1992, 1993), the four-factor model of Carhart (1997), or the
five-factor model of Fama and French (2015). The factor returns are calculated following the
methods of Fama and French (2015, 2018), and the precise procedures are summarized in Table
A1 in the Internet Appendix. To derive the factor returns, we always use all the firms in the
relevant equity universe. For example, when evaluating pooled emerging market portfolios, we
used factors calculated based on all emerging market companies.
To ensure consistency with our data sample, instead of sourcing the factor returns from
French (2020) or AQR (2020), we calculate them ourselves based on all the firms available in
the investigated region. Importantly, for evaluating the liquidity effect in a given region, we
always apply the respective regional factors derived from the same region. In the case of the
factors for the aggregate Global sample, stocks from individual regions—North America,
Europe, Japan, and Asia-Pacific—are sorted into portfolios based on breakpoints calculated for
their regions of origin.
The performance of our factors is qualitatively consistent with those obtained from
French (2020). Table A2 in the Internet Appendix summarizes the basic statistical properties of
20

the factor returns. Furthermore, Figure A1 in the Internet Appendix provides an additional
overview of factor performance.
The results of the investigations of the bivariate portfolios for global, developed, and
emerging markets are summarized in Table 4. Observe the results for the equal-weighted
portfolios in Panel A. The cross-sectional variation of illiquidity premia clearly indicates that
the major source of the premium lies in the smallest companies in the market. For global,
developed, or emerging markets, there is only one size quintile that displays a clear and strong
liquidity effect: the group of stocks with the lowest market capitalization. For instance, for the
global markets, the least liquid stocks in the smallest firm quintile outperform the most liquid
stocks by 1.49% per month (t-stat = 5.75) with an associated six-factor alpha of 1.35% (t-stat =
5.11). Notably, in none of the other quintiles do we record significant outperformance by the
illiquid stocks. In other words, the entire illiquidity premium is driven only by the tiniest
companies in the market.
The analysis of the subsets of developed and emerging markets (Table 4, Panels B and
C) yields consistent results. Again, the significant outperformance by the illiquid companies
can be spotted only in the subset of the smallest firms. Indeed, in this market segment, the
outperformance is impressively sizeable, and the alphas amount to 1.44% (t-stat = 4.65) and
1.73% (t-stat = 4.29) for developed and emerging markets, respectively. In all the other size
quintiles, we record no significant illiquidity premium.
Summing up our conclusions from Table 4, any illiquidity premium in the international
stock markets is generated by the smallest quintile of companies. Globally, this 20% of firms
may initially appear to still constitute a meaningful and investable group. Indeed, given the
large number of stocks in our sample, the average number of stocks in individual bivariate
portfolios equals 693 for the global sample, 459 for developed markets, and 168 for emerging
21

markets (see Table 4 for details), implying that there are almost 3,500 different companies in
the smallest firm quintile. Nonetheless, to fully comprehend the economic significance of this
subset, it is necessary to also take into account their capitalization.
Table 5 reports the average capitalizations and market shares of different portfolios from
bivariate sorts. A quick look at the numbers allows us to understand the market significance of
the companies responsible for the illiquidity premium. As indicated in Table 5, Panel B, the
entire smallest firm quintile in the global markets accounts for as little as 0.21% of total market
capitalization. The developed and emerging markets' values are similar, equaling to 0.20% and
0.41%, respectively. What is more, the actual market capitalization of the companies included
in these market segments is remarkably small. Globally, the average firm size in different ILLIQ
groups of the smallest firm quintile amounts to about USD 10 to 20 million. The implementation
of any quantitative strategies by large institutional investors in such tiny firms is hard to
imagine. Therefore, the sizable illiquidity premium in the small firm segments in Table 4 can
hardly be captured by any larger market investor.
To conclude, Tables 4 and 5 clearly indicate that the entire illiquidity premium in the
stock market is generated by only a tiny fraction of very small and hardly investable companies.
The vast majority of firms, comprising more than 99% of the total stock market capitalization,
exhibit no reliable return pattern linked to market liquidity.
Finally, to corroborate our findings from bivariate sorts, we supplement them with
robustness checks, in a similar way to all the earlier tests. First, we consider alternative holding
periods: three, six, and twelve months. The outcomes of this experiment, presented in Table A5
of the Internet Appendix, do not invalidate our conclusions in any way.
Second, we test the pricing of liquidity in subperiods. Ben-Rephael, Kadan, and Wohl
(2015) demonstrate that the illiquidity premium in the U.S. market has changed through time
22

along with varying levels of overall market liquidity. Hence, we may theorize that the liquidity
effect used to reliably drive returns on firms of different sizes in the past, but more recently,
any illiquidity premium is visible only in the least-liquid (that is: smallest) companies. To shed
some light on this issue from an international perspective, Table A6 reports the returns on
bivariate portfolios in subperiods. Specifically, we split our full study period into two halves:
January 1990 to February 2005 and March 2005 to April 2020. The size-liquidity relationship
is similar in both subperiods. In recent years, as in the past, the liquidity was priced solely
among the smallest 20% of firms. In all other size classes, no liquidity effect can be observed.
Third, as an alternative to our baseline bivariate sorts on size and liquidity, we employ
the illiquidity factor portfolios used in Amihud et al. (2015, Table 2). Precisely, we form single-
country two-way factor portfolios from sorts on volatility and ILLIQ, and calculate their average
returns across the countries in our sample. To ensure comparability with Amihud et al. (2015),
we closely replicate their methods, using the same study period, ILLIQ calculation approach,
and portfolio formation procedure. However, contrary to Amihud et al. (2015), we perform this
exercise not only for the full sample, but also for the subset of larger firms defined as in Section
3. The outcomes of this experiment are reported in Table A3 of the Online Appendix. The
results of the replication for the full sample (Table A3, Panel B) are almost identical to those in
Amihud et al. (2015), clearly corroborating their findings (Table A3, Panel A). For example,
the alphas on return-weighted illiquidity factor portfolios in developed and emerging markets
amount to 0.73% and 1.16%, respectively. Nonetheless, once we discard the smallest firms with
a market inflation-adjusted value below 500 million USD (Table A3, Panel C), the illiquidity
premium is no longer observable. The analogous alphas in the larger firm universe in developed
and emerging countries equal 0.06% and -0.01%, respectively.
Fourth, we turn to alternative liquidity measures, namely, TURN and BAS. In other
words, we replicate the analyses from Tables 4 and 5, substituting ILLIQ with TURN or BAS.
23

Importantly, in this particular case, we do not use the third alternative measure, ZERO, that we
employed before. This is due to the distribution of ZERO in the stock market—the majority of
firms have no zero returns, and very few have more than one—so we are unable to construct
portfolios from double sorts populated by comparable numbers of firms.
The performance of bivariate portfolios from this extra test is reported in Table 6, and
the associated weights and average firm values can be found in Table A7 (Online Appendix).
The BAS-sorted firms produce a significant and powerful illiquidity premium, but only in the
smallest firms quintile. The other capitalization quintiles, representing 99.9% of the total market
capitalization, reveal no liquidity effect. Furthermore, the evidence based on TURN is even
weaker. In this case, we do not observe any liquidity premium in any of the size quintiles.
The results of the experiments with bivariate sorts are consistent with our observations
from Sections 3 and 4, pointing to the special role of microcaps in the creation of the illiquidity
premium. The evidence for the pricing of liquidity outside the microcap segment is virtually
non-existent. In other words, the entire abnormal performance of illiquid stocks seems to be
driven by the smallest firms in the market.
5. Concluding Remarks
In this study, we examine the pricing of liquidity in stock markets in 45 developed and
emerging equity markets through the years 1990-2020. Using several different liquidity
measures—Amihud’s ratio, turnover rate, bid-ask spread, and the number of zero-return days—
we demonstrate that the liquidity effect exists only among microcap stocks that are of negligible
economic significance. When these firms are excluded, hardly any illiquidity premium can be
detected anywhere.
24

Our findings matter for both researchers and market practitioners. This study not only
provides new insights into asset pricing in international stock markets, but also has practical
implications. If illiquidity is not rewarded anywhere except for an irrelevant segment of hardly
tradeable stocks, then it should not be considered as a separate factor in qualitative portfolio
management. Also, the use of illiquidity in a performance evaluation or a cost of capital
estimation may be questionable.
Future studies on the topics researched in this article could be pursued in at least two
directions. First, examinations of analogous patterns in some different, but comparable, asset
classes such as corporate bonds would be valuable. Second, the global financial markets have
undergone remarkable changes in recent decades. New instruments and trading venues
emerged, the composition and structure of investors evolved, and electronic and algorithmic
trading revolutionized how we buy and sell stocks. This raises a fundamental question about
the validity of the existing liquidity measurement methods. Are existing tools sophisticated
enough to capture the changes in data generating processes? These issues remain open for future
research.
25

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149 Paper.
28

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163 Journal of the European Economic Association 6 (2–3), 668–682.
29

Figure 1. Research Sample
The figure presents the number of companies (Panel A) and total market capitalization (Panel B) in the sample.
The values are reported for the subsets of 26 developed and 19 emerging markets, respectively. The study period
is from January 1990 to April 2020.
Panel A: Number of Firms Panel B: Total Market Value
35000 80
Developed markets Developed markets
30000 70
Emerging markets Emerging markets
60
25000
50
20000
40
15000
30
10000
20
5000 10
0 0
1990 1993 1997 2001 2005 2009 2013 2016 1990 1993 1997 2001 2005 2009 2013 2016
30

Figure 2. Changes in Liquidity through Time
The figure presents the medians (Panels A.1 and B.1) and value-weighted averages (Panels A.2 and B.2) of the Amihud's
illiquidity measure (ILLIQ, multiplied by 10^5) and bid-ask spread (BAS) in the cross-section of stocks in our sample. The
values are reported separately for the subsets of 26 developed and 19 emerging markets, respectively. The study period is
from January 1990 to April 2020.
Panel A.1: Median ILLIQ
0.6
Developed markets
Emerging markets
0.4
0.2
0.0
1990 1991 1993 1995 1997 1999 2001 2002 2004 2006 2008 2010 2012 2013 2015 2017 2019
Panel A.2: Value-Weighted Average ILLIQ

0.6
Developed markets
Emerging markets
0.4
0.2
0.0
1990 1991 1993 1995 1997 1999 2001 2002 2004 2006 2008 2010 2012 2013 2015 2017 2019
Panel B.1: Median BAS

3.0%
Developed markets
Emerging markets
2.0%
1.0%
0.0%
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Panel B.2: Value-Weighted Average BAS

1.0%
Developed markets
Emerging markets
0.5%
0.0%
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
31

Figure 3. Proportion of Small Companies in the Sample through Time
The figure presents the proportion of companies through time qualified as "microcap" (i.e., with a total market capitalization
not exceeding a value of USD 500 million, inflation-adjusted to December 31st 2019). Panel A reports the statistics for the
full global sample of 45 counties, and Panels B and C concern the 26 developed and 19 emerging markets, respectively.
The study period is from January 1990 to April 2020.
Panel A: Global Markets
8%
6%
4%
2%
0%
1990 1991 1993 1995 1997 1999 2001 2002 2004 2006 2008 2010 2012 2013 2015 2017 2019
Panel B: Developed Markets

6%
5%
4%
3%
2%
1%
0%
1990 1991 1993 1995 1997 1999 2001 2002 2004 2006 2008 2010 2012 2013 2015 2017 2019
Panel C: Emerging Markets

30%
25%
20%
15%
10%
5%
0%
1990 1991 1993 1995 1997 1999 2001 2002 2004 2006 2008 2010 2012 2013 2015 2017 2019
32

Table 1. Statistical Properties of Major Variables
The table reports the basic statistical properties of the major variables used in this study: monthly stock return (RET,
expressed in percentage terms), Amihud's illiquidity ratio (ILLIQ, multiplied by 10^5), book-to-market ratio (BM),
momentum (MOM), short-term reversal (REV), stock market beta (BETA), idiosyncratic risk (IVOL), co-skewness
(COSKEW), operating profitability (OP), and asset growth (AG). In addition, ln(Cap) refers to the natural logarithm of a
company size expressed in USD million. The reported statistics are the mean, standard deviation, skewness, and kurtosis,
as well as the median, first quartile and third quartile values. Panel A reports the descriptive statistics for all 45 countries
included in our sample; Panels B and C report them for the subsets of 26 developed and 19 emerging markets, respectively.
Panel D reports the average Pearson product-moment pairwise cross-sectional correlations between different variables,
and the values above and below the diagonal refer to developed and emerging markets, respectively. The average monthly
number of stocks equals 17,324 for global markets (Panel A), 12,682 for developed markets (Panel B), and 4,642 for
emerging markets (Panel C). All the reported numbers are time-series averages of monthly values. To obtain them, we first
calculate the statistical property for each month and then calculate the time-series average across all the months in the study
period (January 1990 to April 2020).
RET ln(Cap) ILLIQ BM MOM REV BETA IVOL COSKEW OP AG
Panel A: Descriptive Statistics for Global Markets
Mean 1.003 5.185 2.320 1.027 0.141 0.010 0.919 0.161 -3.003 0.109 0.137
St. deviation 14.710 2.054 8.291 1.094 0.742 0.147 0.796 0.100 21.677 0.413 0.416
Skewness 3.156 0.222 5.481 2.868 14.653 3.138 0.850 2.784 -0.154 -2.136 3.558
Kurtosis 48.895 3.053 35.447 13.853 957.951 47.982 6.864 18.644 4.582 18.495 21.258
1st Quartile -6.029 3.764 0.002 0.383 -0.185 -0.061 0.406 0.099 -13.947 0.045 -0.039
Median -0.124 5.057 0.035 0.708 0.034 -0.001 0.815 0.135 -2.287 0.142 0.059
3rd Quartile 6.233 6.526 0.502 1.249 0.302 0.062 1.334 0.189 8.231 0.252 0.184
Panel B: Descriptive Statistics for Developed Markets
Mean 0.952 5.260 1.502 1.006 0.129 0.009 0.969 0.171 -3.630 0.078 0.140
St. deviation 14.500 2.057 5.667 0.999 0.717 0.144 0.828 0.107 23.538 0.469 0.455
Skewness 3.322 0.325 5.673 2.685 13.682 3.277 0.794 2.633 -0.106 -2.441 3.712
Kurtosis 52.825 3.045 37.812 12.763 757.131 51.167 6.670 16.785 4.465 20.085 22.612
1st Quartile -5.786 3.839 0.002 0.403 -0.176 -0.058 0.447 0.104 -15.985 0.027 -0.042
Median -0.078 5.057 0.029 0.725 0.036 -0.001 0.872 0.142 -3.087 0.134 0.054
3rd Quartile 6.004 6.573 0.358 1.241 0.284 0.060 1.399 0.203 9.012 0.241 0.176
Panel C: Descriptive Statistics for Emerging Markets
Mean 1.269 4.878 4.945 1.123 0.201 0.013 0.784 0.128 -0.873 0.190 0.146
St. deviation 15.380 1.919 15.047 1.407 0.790 0.154 0.625 0.061 12.800 0.302 0.366
Skewness 2.421 -0.138 4.510 3.024 8.314 2.472 0.633 3.276 0.089 0.184 3.144
Kurtosis 30.913 2.989 25.807 14.619 265.269 32.016 6.050 35.506 3.567 13.558 18.156
1st Quartile -6.950 3.501 0.008 0.339 -0.196 -0.069 0.373 0.090 -8.694 0.073 -0.031
Median -0.332 4.989 0.098 0.671 0.050 -0.003 0.715 0.115 -1.116 0.166 0.074
3rd Quartile 7.308 6.240 1.616 1.319 0.394 0.073 1.139 0.151 6.670 0.292 0.217
Panel D: Pairwise Correlation Coefficients
RET ln(Cap) ILLIQ BM MOM REV BETA IVOL COSKEW OP AG
RET -0.021 0.029 0.029 0.019 -0.019 -0.013 0.010 -0.005 0.002 -0.013
ln(Cap) -0.030 -0.382 -0.360 0.109 0.040 0.036 -0.512 0.082 0.293 0.047
ILLIQ 0.028 -0.467 0.170 -0.037 0.024 -0.041 0.458 -0.012 -0.178 -0.053
BM 0.033 -0.472 0.276 -0.229 -0.104 -0.026 0.174 -0.010 -0.072 -0.103
MOM 0.020 0.113 -0.033 -0.197 0.014 -0.031 0.017 -0.033 0.050 0.029
REV -0.003 0.042 0.022 -0.088 0.017 -0.015 0.027 0.001 0.002 -0.013
BETA -0.012 0.107 -0.130 -0.069 -0.005 -0.010 0.204 -0.009 -0.078 0.050
IVOL 0.020 -0.440 0.409 0.233 0.085 0.045 0.122 -0.079 -0.362 0.018
COSKEW -0.013 0.054 -0.006 0.006 -0.034 -0.003 -0.047 -0.019 0.027 -0.028
OP 0.005 0.173 -0.095 -0.177 0.067 0.006 -0.022 -0.134 0.011 0.100
AG -0.013 0.137 -0.090 -0.114 0.048 -0.010 0.063 -0.066 -0.018 0.123
33

Table 2. Baseline Cross-Sectional Regressions
The table reports the average slope coefficients from the cross-sectional regressions in the style of Fama and MacBeth (1973). The dependent variable is the stock-level excess returns.
The independent variables are Amihud's illiquidity measure (ILLIQ) and a set of control variables: logarithm of market capitalization (MV), the logarithm of the book-to-market ratio
(BM), momentum (MOM), stock market beta (BETA), short-term reversal (REV), idiosyncratic risk (IVOL), coskewness (COSKEW), operating profitability (OP), and percentage asset
growth (AG). ̅𝑅̅̅2̅ is the average cross-sectional coefficient of determination (expressed as a percentage). The numbers in brackets are Newey-West (1987) adjusted t-statistics. The
coefficients are obtained using four different estimation approaches: ordinary least squares (OLS) regression based on all firms in the sample (AF-OLS), OLS regression based on the
subset of bigger firms with a market capitalization exceeding USD 500 million (BF-OLS), OLS regression based on the subset of micro firms with a market capitalization not exceeding
USD 500 million (SF-OLS), and weighted least squares (WLS) regression with market capitalizations used as weights based on all firms in the sample (AF-WLS). Panel A reports the
results for all 45 countries included in our sample (global markets); Panels B and C display the outcomes for the subsets of 26 developed and 19 emerging markets, respectively. The
study period is from January 1990 to April 2020.
Panel A: Global Markets Panel B: Developed Markets Panel C: Emerging Markets

AF-OLS BF-OLS MF-OLS AF-WLS AF-OLS BF-OLS MF-OLS AF-WLS AF-OLS BF-OLS MF-OLS AF-WLS
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10 (11) (12)
Univariate Regressions
ILLIQ 0.02 -0.14 0.02 0.01 0.03 -0.22 0.03 0.01 0.23 0.08 0.23 0.21
(2.01) (-1.00) (2.38) (0.45) (2.20) (-1.30) (2.83) (0.17) (1.06) (0.32) (0.93) (1.31)
̅̅̅
R2 0.17 0.12 0.20 0.18 0.13 0.13 0.19 0.13 0.16 0.68 0.89 0.16
Multivariate Regressions
ILLIQ 0.03 -0.14 0.02 0.04 0.04 -0.16 0.03 0.07 -0.07 -0.61 0.10 -0.15
(2.45) (-1.07) (2.11) (1.23) (3.16) (-1.02) (2.43) (1.46) (-0.32) (-1.84) (0.42) (-0.97)
MV 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
(-4.94) (-0.73) (-9.35) (-4.94) (-4.81) (-0.64) (-12.20) (-1.46) (-4.09) (-1.24) (-3.67) (-1.81)
BM 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
(0.56) (4.16) (-1.27) (2.86) (3.60) (3.82) (2.92) (3.02) (0.83) (3.05) (0.31) (1.37)
MOM 0.00 0.00 0.01 0.00 0.00 0.00 0.01 0.00 0.00 0.01 0.01 0.00
(4.40) (3.03) (5.36) (2.06) (3.20) (2.88) (4.28) (1.47) (3.29) (3.57) (3.36) (1.90)
BETA 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.01 0.00
(-0.24) (-0.02) (-0.02) (0.44) (-1.09) (-0.04) (-1.03) (-0.08) (0.62) (0.03) (1.80) (-0.14)
REV -0.02 0.00 -0.02 -0.01 -0.02 -0.01 -0.02 -0.02 -0.02 -0.01 -0.02 -0.01
(-4.61) (-0.92) (-5.30) (-1.93) (-5.68) (-1.68) (-6.04) (-2.80) (-2.45) (-0.83) (-2.21) (-0.82)
IVOL 0.01 -0.04 0.01 -0.05 0.01 -0.04 0.01 -0.04 0.03 -0.03 0.04 -0.03
(1.28) (-2.46) (0.93) (-2.55) (1.40) (-2.60) (0.81) (-1.78) (1.33) (-0.80) (1.26) (-0.65)
COSKEW -0.01 -0.05 -0.01 -0.08 0.00 -0.06 -0.02 0.00 0.00 0.13 -0.08 0.00
(-0.39) (-1.11) (-0.24) (-1.65) (-0.91) (-1.67) (-0.89) (-1.12) (-0.28) (0.67) (-0.59) (-0.42)
PROF 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
(-0.13) (2.49) (-0.97) (0.70) (4.10) (2.10) (-0.87) (1.21) (1.62) (2.69) (0.07) (0.98)
AG 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
(-3.26) (-3.13) (-0.08) (-1.93) (-2.91) (-1.98) (0.17) (-1.64) (-0.50) (-2.14) (-0.53) (-0.45)
̅̅̅
R2 4.53 8.75 4.10 4.30 4.84 9.11 4.42 4.84 10.09 16.41 10.33 10.09
34

Table 3. Cross-Sectional Regressions Based on Alternative Liquidity Measures
The table reports the average slope coefficients (multiplied by 100) from the cross-sectional regressions in the style of
Fama and MacBeth (1973). The dependent variable is the stock-level excess returns. The independent variables are
alternative liquidity measures: turnover ratio (TURN), bid-ask spread (BAS), and the number of non-trading days (ZERO).
The left section contains coefficients estimated using univariate regressions, while the coefficients in the right section are
based on multivariate regressions incorporating a set of control variables: logarithm of market capitalization (MV),
logarithm of the book-to-market ratio (BM), momentum (MOM), stock market beta (BETA), short-term reversal (REV),
idiosyncratic risk (IVOL), coskewness (COSKEW), operating profitability (OP), and percentage asset growth (AG). The
numbers in brackets are Newey-West (1987) adjusted t-statistics. The coefficients are obtained using four different
estimation approaches: ordinary least squares (OLS) regression based on all firms in the sample (AF-OLS), OLS regression
based on the subset of bigger firms with a market capitalization exceeding USD 500 million (inflation-adjusted to
December 2019) (BF-OLS), OLS regression based on the subset of micro firms with market capitalization not exceeding
USD 500 million (inflation-adjusted to December 2019) (SF-OLS), and weighted least squares (WLS) regression with
market capitalizations used as weights based on all firms in the sample (AF-WLS). Panel A reports the results for all 45
countries included in our sample (global markets); Panels B and C display the outcomes for the subsets of 26 developed
and 19 emerging markets, respectively. The study period is from January 1990 to April 2020.
No control variables Control variables included

AF-OLS BF-OLS MF-OLS AF-WLS AF-OLS BF-OLS MF-OLS AF-WLS
Panel A: Global markets
TURN 1.36 0.30 4.99 -0.93 1.19 0.41 6.29 0.17
(0.794) (0.218) (0.970) (-0.301) (0.888) (0.331) (1.488) (0.085)
BAS 5.88 -0.77 5.80 0.60 5.16 -0.52 4.34 -0.75
(7.657) (-0.471) (8.260) (0.310) (7.415) (-0.390) (6.234) (-0.502)
ZERO 0.04 0.03 0.04 0.02 0.02 0.00 0.01 0.02
(5.811) (0.414) (5.401) (3.345) (3.441) (-0.063) (1.863) (1.646)
Panel B: Developed markets
TURN 0.57 0.69 3.57 -0.33 0.44 1.45 4.92 -0.47
(0.289) (0.431) (0.626) (-0.192) (0.300) (1.011) (1.040) (-0.276)
BAS 6.52 -4.38 6.58 -2.24 5.58 -2.11 3.84 -0.47
(7.814) (-1.305) (8.434) (-1.146) (7.218) (-0.750) (5.496) (-0.257)
ZERO 0.04 -0.01 0.04 -0.01 0.02 -0.04 0.01 -0.02
(4.942) (-0.092) (4.783) (-0.685) (2.658) (-0.311) (0.944) (-1.390)
Panel C: Emerging markets
TURN -4.18 4.49 -14.89 6.93 10.40 -3.68 12.56 5.45
(-0.406) (0.705) (-0.692) (1.108) (1.085) (-0.451) (0.486) (0.828)
BAS 3.06 -0.76 2.68 0.52 3.05 -0.14 3.40 -0.53
(2.516) (-0.315) (2.635) (0.180) (2.734) (-0.087) (3.010) (-0.300)
ZERO 0.14 0.25 0.21 -0.03 0.01 0.04 0.02 -0.09
(2.303) (0.711) (2.404) (-0.201) (0.180) (0.140) (0.291) (-0.666)
35

Table 4. Returns on Portfolios from Bivariate Sorts on Size and Liquidity
The table reports the average returns on equal-weighted portfolios from two-way dependent sorts on size and
liquidity. In the first step, we sort the companies into size quintiles based on their market capitalization at the end
of the previous month. In the second step, within each size quintile, we sort the stocks into liquidity quintiles based
on Amihud's illiquidity measure. High ILLIQ (Low ILLIQ) indicates the portfolio of stocks with the highest
(lowest) ILLIQ. H-L is a long-short spread portfolio buying (selling) the High ILLIQ (Low ILLIQ) quintile of
stocks. Average refers to the average return across all the size quintiles. The table also reports the six-factor model
alpha, αF6, on the long-short portfolios. The numbers in parentheses are Newey-West (1987) adjusted t-statistics.
The mean returns and alphas are expressed in percentage terms. Panel A reports the results for all 45 countries
included in our sample; Panels B and C display the outcomes for the subsets of 26 developed and 19 emerging
markets, respectively. The average monthly number of stocks in individual bivariate portfolios equals 693 for
Panel A, 459 for Panel B, and 168 for Panel C. The study period is from January 1990 to April 2020.
Low High
2 3 4 H-L t-statR αF6 t-statα
ILLIQ ILLIQ
Panel A: Global Sample
Small 0.95 0.81 1.11 1.59 2.44 1.49 (5.75) 1.35 (5.11)
2 0.49 0.43 0.41 0.42 0.48 -0.01 (-0.03) -0.08 (-0.32)
3 0.42 0.22 0.25 0.30 0.29 -0.14 (-0.55) -0.17 (-0.60)
4 0.52 0.38 0.24 0.31 0.30 -0.22 (-0.78) -0.42 (-1.45)
Big 0.40 0.36 0.36 0.30 0.26 -0.14 (-0.83) -0.14 (-0.98)
Average 0.56 0.44 0.47 0.58 0.75 0.20 (1.12) 0.11 (0.57)
Panel B: Developed Markets
Small 1.20 0.79 0.96 1.30 2.73 1.53 (5.29) 1.44 (4.65)
2 0.55 0.52 0.39 0.46 0.43 -0.12 (-0.49) -0.04 (-0.16)
3 0.28 0.32 0.24 0.27 0.24 -0.04 (-0.18) 0.19 (0.83)
4 0.42 0.37 0.23 0.29 0.25 -0.17 (-0.89) 0.17 (0.83)
Big 0.41 0.40 0.40 0.34 0.26 -0.15 (-0.87) -0.01 (-0.06)
Average 0.57 0.48 0.44 0.53 0.78 0.21 (1.24) 0.35 (1.91)
Panel C: Emerging Markets
Small 1.32 1.64 1.53 1.79 2.79 1.46 (3.55) 1.73 (4.29)
2 0.81 1.06 1.06 0.96 0.87 0.07 (0.17) 0.41 (1.10)
3 1.19 1.09 0.37 0.57 0.45 -0.75 (-1.46) -0.84 (-2.75)
4 0.72 0.77 0.40 0.44 0.68 -0.05 (-0.10) -0.18 (-0.66)
Big 0.25 0.25 0.16 0.17 0.39 0.14 (0.47) 0.01 (0.05)
Average 0.86 0.96 0.71 0.79 1.03 0.17 (0.58) 0.23 (1.02)
36

Table 5. Size and Market Share of Firms in Portfolios from Bivariate Sorts on Size and
Liquidity
The table reports the average market capitalization (Panel A, in USD billions) and market share (Panel B, in
percentage terms) of the companies in portfolios from two-way dependent sorts on size and liquidity. In the first
step, we sort the companies into size quintiles based on their market capitalization at the end of the previous month.
In the second step, within each size quintile, we sort the stocks into liquidity quintiles based on Amihud's illiquidity
measure (ILLIQ). The market value and share are averaged: first in the cross-section and second in the time-series.
The upper section reports the results for all 45 countries included in our sample; the middle and lower sections
display the outcomes for the subsets of 26 developed and 19 emerging markets, respectively. The study period is
Panel A: Average firm size (USD bio.) Panel B: Average market share (%)
Low High Low High
2 3 4 2 3 4 Total
ILLIQ ILLIQ ILLIQ ILLIQ
Global Sample
Small 0.02 0.02 0.02 0.01 0.01 0.06 0.05 0.04 0.04 0.03 0.21
2 0.07 0.07 0.07 0.06 0.06 0.17 0.16 0.16 0.15 0.14 0.79
3 0.20 0.18 0.17 0.17 0.16 0.48 0.44 0.41 0.40 0.39 2.11
4 0.65 0.56 0.52 0.48 0.47 1.57 1.35 1.26 1.16 1.12 6.46
Big 23.82 5.49 3.30 2.44 2.50 57.35 13.22 7.96 5.88 6.01 90.43
Developed Markets
Small 0.03 0.02 0.02 0.02 0.01 0.06 0.05 0.04 0.03 0.02 0.20
2 0.08 0.07 0.07 0.07 0.07 0.16 0.15 0.14 0.14 0.13 0.71
3 0.21 0.19 0.18 0.17 0.17 0.40 0.38 0.36 0.34 0.33 1.82
4 0.75 0.62 0.56 0.51 0.49 1.46 1.23 1.09 1.00 0.96 5.74
Big 29.89 6.94 3.96 2.79 3.01 58.73 13.64 7.78 5.47 5.91 91.54
Emerging Markets
Small 0.02 0.02 0.02 0.01 0.01 0.10 0.10 0.09 0.07 0.05 0.41
2 0.06 0.06 0.06 0.06 0.06 0.31 0.29 0.28 0.27 0.26 1.41
3 0.21 0.18 0.16 0.16 0.15 1.00 0.84 0.78 0.76 0.72 4.10
4 0.52 0.47 0.45 0.45 0.44 2.48 2.24 2.15 2.16 2.10 11.14
Big 9.14 2.54 2.04 1.97 1.71 43.56 12.08 9.74 9.40 8.16 82.94
37

Table 6. Returns on Portfolios from Bivariate Sorts on Size and Alternative Liquidity
Measures
The table reports the average returns on equal-weighted portfolios from two-way dependent sorts on size and two
alternative liquidity measures: turnover ratio (TURN) and bid-ask spread (BAS). In the first step, we sort the
companies into size quintiles based on their market capitalization at the end of the previous month. In the second
step, within each size quintile, we sort the stocks into liquidity quintiles based on TURN (Panel A) and BAS (Panel
B). High (Low) indicates the portfolio of stocks with the highest (lowest) ILLIQ. H-L is a long-short spread
portfolio buying (selling) the High (Low) quintile of stocks. Average refers to the average return across all the size
quintiles. The table also reports the six-factor model alpha, αF6, on the long-short portfolios. The numbers in
parentheses are Newey-West (1987) adjusted t-statistics. The mean returns and alphas are expressed in percentage
terms. The calculations are based on all 45 countries included in our sample (global markets). The study period is
Low 2 3 4 High H-L t-statR αF6 t-statα
Panel A: Sorts on TURN
Small 1.38 1.33 1.47 1.42 1.31 -0.07 (-0.32) 0.00 (-0.01)
2 0.56 0.42 0.41 0.51 0.34 -0.22 (-0.90) -0.19 (-0.75)
3 0.43 0.20 0.24 0.34 0.27 -0.16 (-0.63) -0.13 (-0.45)
4 0.64 0.32 0.21 0.26 0.32 -0.32 (-1.04) -0.51 (-1.64)
Big 0.36 0.46 0.31 0.26 0.28 -0.08 (-0.40) -0.01 (-0.03)
Average 0.67 0.55 0.53 0.56 0.50 -0.17 (-0.89) -0.17 (-0.80)
Panel B: Sorts on BAS
Small 1.03 0.71 0.73 1.12 3.13 2.10 (4.55) 2.38 (4.66)
2 0.80 0.65 0.27 0.00 -0.04 -0.84 (-2.40) -0.70 (-1.79)
3 0.95 0.30 0.08 -0.13 -0.12 -1.07 (-2.57) -1.03 (-2.31)
4 1.16 0.49 0.24 0.13 -0.05 -1.21 (-1.98) -1.61 (-4.64)
Big 0.18 0.08 -0.05 0.07 0.08 -0.10 (-0.44) -0.47 (-2.48)
Average 0.82 0.44 0.25 0.24 0.60 -0.22 (-0.79) -0.29 (-1.00)
38

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Liquidity and the Cross-Section of International Stock Returns *

Keywords: illiquidity premium, liquidity effect, international markets, microcaps, Amihud’s

JEL codes: G12, G15.

This version: March 19th, 2021

Electronic copy available at: https://ssrn.com/abstract=3520760

We perform a comprehensive investigation of the illiquidity premium in international stock

effect can be observed.

Keywords: illiquidity premium, liquidity effect, international markets, microcaps, Amihud's

JEL codes: G12, G15.

Electronic copy available at: https://ssrn.com/abstract=3520760

large-scale global stock-level study available to an international audience is restricted to

Electronic copy available at: https://ssrn.com/abstract=3520760

construction, 95 of 102 liquidity measures are irrelevant for future returns.

conduct a wide-ranging evaluation of liquidity pricing in the cross-section of returns in

provide insights into its significance.

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three different major methods: examinations of illiquidity premium portfolios, cross-sectional

the proportion of zero-return days (Lesmond, Ogden, and Trzcianka 1999).

We start with cross-sectional regressions that examine the relationship between

very small companies—frequently referred to as microcaps—that have limited economic

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exhibit negligible economic importance. Within this market segment, constituting

capturing it with quantitative strategies may pose severe challenges in practice.

contribution of microcaps to the illiquidity premium.

univariate and bivariate sorts. Finally, Section 5 concludes the study.

enough since the number of small firms is large.

Electronic copy available at: https://ssrn.com/abstract=3520760

methods and variable calculations.

2.1. Data Sources and Sample Preparation

Switzerland, Taiwan, U.K., USA) and 19 classified as emerging (Argentina, Bangladesh,

Datastream. The comprehensive coverage provided by Datastream is comparable to that of

historical data dating back to December 1987.

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in the sample through time.

[Insert Figure 1 here]

2.2. Liquidity Measurement

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(i.e., greater illiquidity).

indicates greater illiquidity.

in Chung and Zhang (2014):

1 𝑁𝑜𝑇𝐷𝑖,𝑡 𝑎𝑠𝑘𝑖,𝑡,𝑑 −𝑏𝑖𝑑𝑖,𝑡,𝑑

lower level of liquidity.

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(2007), among others:

best price impact proxy.

robust to different windows.

Figure 2 provides an overview of changes in average liquidity (measured with ILLIQ

Electronic copy available at: https://ssrn.com/abstract=3520760

generally improves over time.

[Insert Figure 2 here]

2.3. Control Variables

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three-factor model as in Ang et al. (2006):

high-minus-low factors, respectively, calculated for individual countries according to the

and 𝐶𝑂𝑆𝐾𝐸𝑊𝑖,𝑡 are the estimated regression parameters.

divided by book-value to equity. Company investment (AG) is estimated as in Cooper, Gulen,

Electronic copy available at: https://ssrn.com/abstract=3520760