How is Liquidity Priced in Global Markets?

Published: 27 January 2022

Investors pay a premium for liquidity, but exactly how much do they pay and how does that vary? Desautels Professor Vihang Errunza investigates that question with a new international asset pricing model.

A security with a high level of liquidity can be traded quickly and easily, making it especially valuable to institutional investors who manage large positions. Open markets like Canada and the United States allow investors from around the world to buy and sell securities, which keeps trading volumes high and sustains high levels of liquidity for many stocks. But when markets erect barriers to investment, it can have the opposite effect.

Some emerging markets restrict investment to their own citizens—with a smaller number of shareholders, each one takes on a larger share of the risk. This type of stock is less liquid and positions can’t be exited as easily. Errunza’s pricing model shows how to price these non-investable stocks. Taking the model to data from 42 countries, they find that non-investable stocks had higher expected returns because they are more illiquid than investable stocks and their liquidity level is priced and because they entail a local risk premium. Therefore, in addition to local market risk, the level of liquidity of a non-investable stock is important to explain its expected return.

Authors: Ines Chaieb, Vihang Errunza, and Hugues Langlois

Publication: The Review of Financial Studies, Volume 34, Issue 9, September 2021, Pages 4216-4268


We develop a new global asset pricing model to study how illiquidity interacts with market segmentation and investability constraints in 42 markets. Noninvestable stocks that can only be held by foreign investors earn higher expected returns compared to freely investable stocks due to limited risk sharing and higher illiquidity. In addition to the world market premium, on average, developed and emerging market noninvestables earn an annual unspanned local market risk premium of 1.17% and 9.04%⁠, and a liquidity level premium of 1.06% and 2.39%⁠, respectively. These results obtained in a conditional setup are robust to the choice of liquidity measure.

Desautels 22

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