Drs. Sandra Mortal and Robert Wood recently accepted for publication in Financial Management
For release: November 21, 2016
Dr. Sandra Mortal, associate professor of Finance, and Dr. Robert Wood, Professor Emeritus in the department of Finance, recently had their paper accepted for publication in Financial Management. The paper is entitled "Market Illiquidity and Conditional Equity Premium." Drs. Mortal and Wood co-authored the paper with Dr. Hui Guo, University of Cincinnati, and Dr. Robert Savickas, George Washington University.
The authors examine the time-series relation between aggregate bid-ask spreads and conditional equity premium. They document that average marketwide relative effective bid-ask spreads forecast aggregate market returns only when controlling for average idiosyncratic variance. This control allows the authors to document the otherwise elusive relation between illiquidity and returns. The reason is that idiosyncratic variance correlates positively with spreads but has a negative effect on conditional equity premium, causing an omitted variable bias. The results are robust to standard return predictors, alternative illiquidity measures, and out-of-sample tests. These findings are important because they provide strong support for the literature's conjecture that marketwide liquidity is an important asset pricing risk factor.