Academic Studies

“Liquidity can be defined as the degree to which large size transactions can be carried out in a timely fashion with a minimal impact on prices. In a liquid market, economic agents would be able to buy or sell an unlimited amount of a security quickly, at low cost, and at a price close to the observed price. On the other side, an illiquid market is one where economic agents would be able to trade securities only at prices different from the last traded price and to carry out large size transactions only with a long time lag. Hence, the lack of liquidity results in a discrepancy between the price and the ‘fair value’ of a given security.” (Bayer, Borell & Moslener 2006)
Liquidity and REIT Stocks
Subrahmanyam [2007]
Avanidhar Subrahmanyam, “Liquidity, Return, and Order-Flow Linkages Between REITs and the Stock Market,” Real Estate Economics 35(3):383-408, Fall 2007.
“The difference between the spreads for REIT and non-REIT stocks has narrowed in recent years. In particular, REIT spreads have dropped to levels very close to that of non-REIT stocks following decimalization.”
Abstract, and published version available for purchase, HERE. Pre-publication draft available for free HERE.
Benveniste, Capozza & Seguin [2001]
Lawrence Benveniste, Dennis R. Capozza, and Paul J. Seguin, “The Value of Liquidity,” Real Estate Economics 29(4):633-660, Winter 2001.
“Due to the unique experimental design inherent in REITs, especially the precision of underlying asset values, we are able to not only verify a link between liquidity and required returns but we are able to accurately quantify these gains. … Specifically, we find that exchange trading increases shareholder wealth by around 10–15% at the margin compared to the relatively illiquid real estate market. However, our estimates of wealth creation jump to around 23% when comparing exchange traded claims to nontrading ones.”
Abstract, and published version available for purchase, HERE.
Marcato & Ward [2007]
Gianluca Marcato & Charles Ward, “Back from Beyond the Bid-Ask Spread: Estimating Liquidity in International Markets,” Real Estate Economics 35(4):599-622, Winter 2007.
“Experience in the U.S. suggests that the development of REITs has increased liquidity and has therefore contributed to improved operational efficiency in real estate markets. ... Once a REIT is listed on the NYSE, the size of the firm does not matter because the market will guarantee the existence of analysts looking at that company and hence its liquidity.”
Abstract, and published version available for purchase, HERE.
Danielsen & Harrison [2007]
Bartley R. Danielsen & David M. Harrison, “The Impact of Property Type Diversification on REIT Liquidity,” Journal of Real Estate Portfolio Management 13(4):329-343, October-December 2007.
“REITs focusing their investment activities within a single property type appear to be characterized by lower spreads.”
Published version available for free HERE.
Illiquidity and Direct (Unsecuritized) Real Estate Returns
Lin, Liu & Vandell [2009]
Zhenguo Lin, Yingchun Liu, and Kerry D. Vandell, “Marketing Period Risk in a Portfolio Context: Comment and Extension,” Journal of Real Estate Finance and Economics 38(2):183-191, February 2009.
“We show that, unlike other nonsystematic risks, real estate illiquidity cannot be diversified away by increasing the number of properties in a portfolio. ... Even large institutional portfolio managers must adjust for the illiquidity present in real estate portfolios and cannot assume that it will be diversified away.”
Abstract, and published version available for purchase, HERE.
Lin & Liu [2008]
Zhenguo Lin and Yingchun Liu, “Real Estate Returns and Risk with Heterogeneous Investors,” Real Estate Economics 36(4):753-776, Winter 2008.
“The traditional valuation of real estate return and risk, which is based solely on the return distribution of a successful sale without considering the uncertainty of time on market and the investor’s financial circumstances, underestimates real estate risk and exaggerates real estate returns. ... Our empirical that the Sharpe ratio estimated by the traditional approach is seriously overstated—to the largest extent for investors with high financial distress. In addition, we find that, given the typical 5- to 7-year holding period for real estate, the Sharpe ratios estimated by integrating both price and time on market risk are much in line with the performance of financial assets. These findings can help to explain the apparent ‘risk-premium puzzle’ in real estate.”
Abstract, and published version available for purchase, HERE
Lin & Vandell [2007]
Zhenguo Lin and Kerry D. Vandell, “Illiquidity and Pricing Biases in the Real Estate Market,” Real Estate Economics 35(3):291-330, Fall 2007.
“This article demonstrates the potential pricing biases in traditional real estate valuation methodologies that implicitly assume real estate assets can be sold immediately. The assumption of immediate execution may be reasonable in the financial market where the time to trade an asset is trivial. However, it is certainly not valid in the direct real estate market where the marketing period is not only uncertain by also substantial. Our results suggest that ignoring the existence of a finite and sometimes significant marketing period in real estate can cause the true underlying market return to be much lower than the observed transaction-based return and the underlying market risk to be much higher than the observed transaction-based risk. We conclude that traditional methods of estimation of real estate return and risk not only understate real estate risk, but also overstate real estate returns.”
Abstract, and published version available for purchase, HERE. Pre-publication draft available free HERE.
Liquidity and REIT Management
Riddiough & Wu [2009]
Timothy Riddiough and Zhonghua Wu, “Financial Constraints, Liquidity Management, and Investment,” Real Estate Economics 37(3):447-471, Fall 2009.
“Liquidity is managed through dividend policy and access to short-term bank finance, in which bank lines of credit smooth variation in available cash flow and accelerate investment.”
Abstract, and published version available for purchase, HERE. Pre-publication draft available free HERE.
Hardin & Wu [2009]
William Hardin and Zhonghua Wu, “Banking Relationships and REIT Capital Structure,” Real Estate Economics, forthcoming.
“Banking relationships, developed through repeated borrowing from the same bank(s), help firms mitigate capital market frictions and improve their overall capital acquisition process.... Our results suggest that at least one reason for REITs to use debt is to obtain financial liquidity to reduce property market frictions and take quick action in property acquisitions. ... By subjecting themselves to the monitoring required to acquire bank loans, REITs obtain a source of needed liquid capital. The results also imply that this additional monitoring benefits REITs in the provision of capital from public debt and equity offerings.”
Pre-publication draft available free HERE.
Liquidity and Other Assets
Fang, Noe & Tice [2009]
Vivian W. Fang, Thomas H. Noe, and Sheri Tice, “Stock Market Liquidity and Firm Value,” Journal of Financial Economics 94(1):150-169, October 2009
“This study documents that firms with liquid stocks have better performance as measured by the firm market-to-book ratio. Liquidity increases the information content of market prices and of performance sensitive managerial compensation.”
Abstract, and published version available for purchase, HERE.
Butler, Grullon & Weston [2005]
Alexander W. Butler, Gustavo Grullon, and James P. Weston, “Stock Market Liquidity and the Cost of Issuing Equity,”Journal of Financial and Quantitative Analysis, 2005.
“We show that stock market liquidity is an important determinant of the cost of raising external capital. We find that, ceteris paribus, investment banks’ fees are significantly lower for firms with more liquid stock.”
Published version available for free HERE.
Damodaran [2005]
Aswath Damodaran, “Marketability and Value: Measuring the Illiquidity Discount,” working paper, July 2005.
“We examine why liquid assets may be priced more highly than otherwise similar illiquid assets and why some investors value liquidity more than others. We follow up by presenting the empirical evidence that has accumulated over time and across different assets—financial and real—on the cost of illiquidity. Finally, we consider how we can use the theory and evidence on illiquidity to estimate the effect of illiquidity on the value of an asset.”
Available for free HERE.
Amihud & Mendelson [2005]
Yakov Amihud & Haim Mendelson, “The Liquidity Route to a Lower Cost of Capital,” Journal of Applied Corporate Finance 12(4):8-25, 2005.
“Liquidity appears to be a major determinant of a company’s cost of capital. As theory suggests and empirical tests confirm, the more liquid a company’s securities, the lower its cost of capital and the higher its stock price.”
Abstract, and published version available for purchase, HERE.
Amihud, Mendelson & Pedersen [2005]
Yakov Amihud, Haim Mendelson, and Lasse Heje Pedersen, “Liquidity and Asset Prices,” Foundations and Trends in Finance 1(4):269-364, 2006.
“We review the theories on how liquidity affects the required returns of capital assets and the empirical studies that test these theories. The theory predicts that both the level of liquidity and liquidity risk are priced, and empirical studies find the effects of liquidity on asset prices to be statistically significant and economically important, controlling for traditional risk measures and asset characteristics.”
Published version available for purchase HERE.
Spiegel & Wang [2005]
Matthew Spiegel and Xiaotong Wang, “Cross-sectional Variation in Stock Returns: Liquidity and Idiosyncratic Risk,”working paper, September 2005.
“Stock returns are increasing with the level of idiosyncratic risk and decreasing in a stock’s liquidity. However, while both liquidity and idiosyncratic risk play a role in determining returns, the impact of idiosyncratic risk is much stronger and often eliminates liquidity’s explanatory power.”
Available for free HERE.
Hasbrouck [2005]
Joel Hasbrouck, “Trading Costs and Returns for US Equities: The Evidence from Daily Data,” working paper, February 2005.
“Although these results provide modest support for the hypothesis that trading cost is a priced characteristic, they are not robust. With alternative correlation measures, the relation between returns and liquidity varies considerably in significance and direction.”
Available for free HERE.
Domowitz, Glen & Madhavan [2001]
Ian Domowitz, Jack Glen, and Ananth Madhavan, “Liquidity, Volatility, and Equity Trading Costs Across Countries and Over Time,”International Finance 4(2):221-255, Summer 2001.
“Actual investment performance reflects the underlying strategy of the portfolio manager and the execution costs incurred in realizing those objectives. Execution costs, especially in illiquid markets, can dramatically reduce the notional return to an investment strategy.”
Abstract, and published version available for purchase, HERE.  Pre-published version available for free HERE.
Amihud [2002]
Yakov Amihud, “Illiquidity and Stock Returns: Cross-Section and Time-Series Effects,”Journal of Financial Markets 5(1):31-56, January 2002.
“Over time, expected market illiquidity positively affets ex ante stock excess return. The impact of market illiquidity on stock excess return suggests the existence of an illiquidity premium.”
Available for free HERE.
Chordia, Huh & Subrahmanyam [2007]
Tarun Chordia, Sahn-Wook Huh, and Avanidhar Subrahmanyam, “Theory-Based Illiquidity and Asset Pricing” working paper, May 2007.
“The empirical results provide convincing evidence that theory-based estimates of illiquidity are priced in the cross-section of expected stock returns, even after accounting for risk factors, firm characteristics known to influence returns, and other illiquidity proxies prevalent in the literature.”
Abstract, and published version available for purchase, HERE. Pre-published version available for free HERE.
Watanabe & Watanabe [2008]
Akiko Watanabe and Masahiro Watanabe, “Time-Varying Liquidity Risk and the Cross Section of Stock Returns,” Review of Financial Studies 21(6):2449-2486, 2008.
“We find that liquidity betas vary significantly over time across two distinct states, one with high liquidity betas and the other with low liquidity betas. The high liquidity-beta state exhibits high volatility and a wide cross-sectional dispersion in liquidity betas, and is preceded by a period of declining expectations about future market liquidity. It is also short lived and occurs less than one tenth of the time.”
Abstract, and published version available for purchase, HERE. Pre-published version available HERE.
Bansal [2006]
Naresh Bansal, “Stock Market Illiquidity and the Time-Varying Stock-Bond Return Relation,”working paper, 2006.
“We examine whether time variation in the comovements of daily stock and Treasury bond returns can be linked to measures of stock market illiquidity. The results indicate that the tendency of stocks and bonds to move together decreases following periods of high stock market illiquidity. Overall, our findings suggest that stock market illiquidity has important cross-market pricing influences and that stock-bond diversification benefits increase with stock market illiquidity.”
Available for free HERE.
Karolyi, Lee & van Dijk [2008]
G. Andrew Karolyi, Kuan-Hui Lee, and Mathijs A. van Dijk, “Commonality in Returns, Liquidity, and Turnoever Around the World,” working paper, April 2008.
“Co-movement or ‘commonality’ in stock returns, liquidity, and trading activity increases during times of high market volatility, large market declines, and high interest rates, and is negatively related to capital market openness.”
Available for free HERE.
Fujimoto [2003]
Akiko Fujimoto, “Liquidity and Expected Market Returns: An Alternative Test,” working paper, November 2003.
“The negative illiquidity-return relation is strong when the economy is in recessions and when the short-term interest rate is high. This suggests that investors depress prices more in response to illiquidity shocks when they anticipate higher market illiquidity to accompany a sluggish economy. Thus, illiquidity effects on prices are stronger when investors have greater need to liquidate their financial assets.”
Available HERE.
Pastor & Stambaugh [2003]
Lubos Pastor and Robert F. Stambaugh, “Liquidity Risk and Expected Stock Returns,”Journal of Political Economy 111(3):642-685, June 2003.
“This study investigates whether market-wide liquidity is a state variable important for asset pricing. We find that expected stock returns are related cross-sectionally to the sensitivities of returns to fluctuations in aggregate liquidity.”
Available for free HERE.
Lee [2006]
Kuan-Hui Lee, “The World Price of Liquidity Risk,”working paper, November 2006.
“Cross-sectional as well as time-series tests show that liquidity risk arising from the covariances of individual stocks’ liquidity with global market returns are priced.”
Available for free HERE.
Chen [2008]
Zhanhui Chen, “Volatility of Liquidity, Idiosyncratic Risk and Asset Returns,” working paper, October 2008.
“Previous researchers document a significantly negative correlation between expected returns and the volatility of liquidity. This is puzzling because risk averse agents require a premium for holding stocks with a high volatility of liquidity if liquidity is priced. I find that the volatility of liquidity effect disappears after controlling for idiosyncratic risk.”
Available for free HERE.
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