The effects of non-trading on the illiquidity ratio |
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| Institution: | 1. Birmingham Business School, Birmingham B15 2TY, UK;2. Cyprus University of Technology, Department of Commerce, Finance and Shipping, 3603 Lemesos, Cyprus;3. Aston Business School, Aston University, Birmingham B4 7ET, UK;1. Department of Banking and Finance, Tamkang University, Taiwan;2. Department of Economics, Feng Chia University, Taiwan;3. Department of Economics, University of Nevada, Las Vegas, USA |
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| Abstract: | Using a simulation analysis we show that non-trading can cause an overstatement of the observed illiquidity ratio. Our paper shows how this overstatement can be eliminated with a very simple adjustment to the Amihud illiquidity ratio. We find that the adjustment improves the relationship between the illiquidity ratio and measures of illiquidity calculated from transaction data. Asset pricing tests show that without the adjustment, illiquidity premia estimates can be understated by more than 17% for NYSE securities and by more than 24% for NASDAQ securities. |
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