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Abstract Lou and Shu decompose Amihud’s illiquidity measure (ILLIQ) proposing that its component, the average of inverse dollar trading volume (IDVOL), is sufficient to explain the pricing of illiquidity. Their decomposition misses a component of ILLIQ that is related to illiquidity. We find that this component affects stock returns significantly, both in the cross-section and in time-series. We show that the ILLIQ premium is significantly positive after controlling for mispricing, sentiment, and seasonality. In addition, the aggregate market ILLIQ outperforms market IDVOL in estimating the effect of market illiquidity shocks on realized stock returns.
Amihud et al. (Fri,) studied this question.