Illiquidity pricing and the drivers of market liquidity: Evidence from the Swedish market

Abstract: This thesis has a twofold stock liquidity related purpose. The study is based on Amihud’s ILLIQ, an illiquidity measured defined as the average ratio of the daily absolute stock excess return to SEK volume. In Part I, we test the proposition that illiquidity is priced in the Swedish stock market. Monthly cumulative stock excess returns for OMXS stocks are regressed on ILLIQ and a number of stock characteristics, including beta, size and the book-to-market ratio. All stock characteristics are computed in year y – 1 and are constant over the twelve monthly regressions in year y. First, the monthly regressions are run separately, generating sets of stock characteristic slope coefficients. Then, the null hypotheses of zero mean of the characteristics’ coefficients are tested. The results support the proposed pricing of illiquidity in Swedish stocks over the period from mid 1994 to 2008. In part II, we investigate the drivers of Swedish overall market liquidity over time, defining market liquidity as the average ILLIQ of OMXS stocks. The results support the effect of most of the suggested liquidity drivers on market liquidity, including Swedish and US consumer confidence, implied and realized volatility and foreign capital flow to the Swedish stock market.