Pricing of liquidity: Study of the Stockholm Stock Exchange 1901-1919

Abstract: This paper studies the importance of liquidity in determining security returns. The study is conducted on the Stockholm Stock Exchange, 1901-1919, a market which at the time suffered from low market turnover. We find out-of-sample effects that liquidity levels are significant determinants of returns. Securities with lower liquidity levels earn, on average, higher returns than their liquid comparables. The paper also includes an extensive description of the unique, and previously unexplored, dataset. Equally weighted and market capitalisation weighted indices for the market as a whole and for five separate sectors are reconstructed using three different methods. Time series for P/E ratios, market-to-book ratios, dividend yield and payout ratios are also constructed.