Pricing unexpected illiquidity

The well documented positive relation between returns and lagged illiquidity suggests that illiquidity is a priced characteristic of stocks. Recent studies suggest that stock returns are inversely related to the contemporaneous unexpected illiquidity, which is consistent with price revisions to reflect realized illiquidity. This study analyzes the relations between stock returns and illiquidity innovations and finds that that the negative illiquidity shock premium persists beyond the contemporaneous interval. However, transaction costs overwhelm any potential profits from strategies that attempt to exploit the price adjustments to the shocks, suggesting the markets are efficient with respect to illiquidity information.